MSN Law Office

Co-Ops
Columbus, Ohio

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Formation and Governance

PRACTICE AREAS

Co-Op Formation

What is a co-op?
A cooperative (or co-op) is a rather unique form of business organization in which, broadly speaking, the people who produce or use the products or services offered by a business are also the owners and operators of the business. Some common examples can help to make this definition more useful:

  • Worker co-ops: The workers who contribute their labor to the business are also the owners and managers of the business.
  • Purchasing co-ops: Several businesses come together to pool their purchasing powers, achieving economies of scale that enable each member business to get better pricing on the goods or services they purchase.
  • Producer/farmer/agricultural co-ops: The producers of a product work together to jointly produce, market, and sell their products.
  • Consumer co-ops: The customers who purchase the goods and services from the co-op are also the owners and operators, i.e., grocery co-ops.


In each of these instances, the members of the coop (called patrons) receive distributions of profits from the co-op business (called patronage dividends). However, unlike a typical for-profit business, rather than distributing profits based on equity interest (i.e., I own 30% of the business, so I get 30% of the profits), in a co-op, the patronage dividends are distributed in proportion to each patron’s patronage of the business (i.e., the amount of labor contributed by workers in a worker co-op, the amount of produce provided by farmers in an agricultural co-op, or the amount of purchases by a customer in a consumer co-op).

Co-ops are generally based on democratic control where each member or patron has exactly one vote on all co-op issues, and outside organizations don’t have any control or influence over how the co-op operates.

Co-ops are also similar to nonprofit organizations in that they tend to focus on improving the well-being of their members and the surrounding community. But unlike nonprofits, businesses formed as co-ops are not exclusively “charitable.” Co-ops are usually trying to earn a profit for their patrons. As a business entity, the co-op enjoys the same limited liability protection as entities like LLCs or corporations.

What is needed to start a co-op in Ohio?
In Ohio, co-ops are governed by Chapter 1729 of the Ohio Revised Code. Co-ops are formed when two or more incorporators file the Articles of Incorporation for a Cooperative Association. Ohio law treats co-ops as nonprofit corporations “because they are not organized for the purpose of making a profit for themselves as such, or for the purpose of making a profit for their members as such, but for their members as patrons.” A co-op can be formed for any purpose for which a corporation might be formed. The Articles will also need to provide some information about the capital structure of the co-op (i.e., how much stock the corporation is authorized to issue). 

Next, bylaws are prepared and adopted for the governance and management of the co-op. Like other corporations, the bylaws will typically explain when and how meetings are conducted, membership rights and requirements, the composition of the board of directors, the maintenance of members’ capital accounts and allocations, the rules governing distributions, the withdrawal of members and transfers of their membership stock, etc. 

At this point, a membership agreement and initial corporate resolutions may also be prepared. The membership agreement forms a legally binding agreement for the member to purchase their membership share and confirms that the member meets the eligibility requirements and understands patronage allocation and distributions. 
How are co-ops taxed?

Co-op taxation is a complicated topic, but it’s important to understand the basics if you are considering forming a co-op. While Ohio law treats co-ops as nonprofit corporations, they are generally not tax-exempt entities. (For these purposes, we aren’t addressing the very narrow class of 501(c)(12) organizations, which includes benevolent life insurance associations and cooperative telephone or electric companies.)

Most co-ops are taxed under Subchapter T of the Internal Revenue Code as pass-through entities. In simplest terms, any surplus (or profits) earned by the co-op are distributed to the member-patrons in the form of patronage dividends, and the patrons generally* pay individual income tax on those dividends. In this sense, co-op taxation functions much like the taxation of an LLC with multiple members, except the patronage dividends are based on the member-patrons participation in the co-op rather than some percentage of ownership. (*There is an exemption for consumer coops in which patronage dividends are not treated as taxable income because the dividends are “attributable to personal, living, or family items.”)

But here’s where it gets complicated. Patronage dividends can be distributed in 1 of 3 ways (or some combination of the 3): cash, qualified written notices of allocation, and nonqualified written notices of allocation. Typically, a coop is authorized to retain at least a portion of the patronage dividends each year. In order to do so, the coop must send each patron a written notice of allocation within 8.5 months of the close of the fiscal year, reporting the amount of that patron’s patronage dividend for the year. If the requirements of Subchapter T are met, then the written notice is “qualified,” meaning that the notice is treated like a cash patronage dividend regardless of whether the coop paid out the entire dividend in cash. The coop avoids corporate income tax, but the patron reports the income on their individual tax return (again, regardless of whether the cash was actually paid to the patron). 

In order to meet the Subchapter T requirements, the patrons must receive at least 20% of their dividends in cash, and the patrons must consent to include the face value of their notice in their taxable income. This consent can be obtained through the bylaws, in a separate written consent before the end of the fiscal year, or by endorsing and cashing a “qualified check,” i.e., a specially prepared bank check that establishes the patron’s consent to include the entire patronage allocation in their taxable income. As a practical matter, most coops obtain consent through the bylaws, and qualified checks are rarely, if ever, used. 

If the written notice of allocation does not meet the Subchapter T requirements, it is considered non-qualified. In that case, the coop pays regular corporate income tax on the amount of the non-qualified allocations but can recover the tax paid by later paying out the cash to the patrons. The individual patron would not pay any personal income tax on the non-qualified allocation until the coop actually pays out money to the patron.