[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1388-1]

[Page 796-801]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1388-1  Definitions and special rules.

    (a) Patronage dividend--(1) In general. The term patronage dividend 
means an amount paid to a patron by a cooperative organization subject 
to the provisions of part I, subchapter T, chapter 1 of the Code, which 
is paid:
    (i) On the basis of quantity or value of business done with or for 
such patron,
    (ii) Under a valid enforceable written obligation of such 
organization to the patron to pay such amount, which obligation existed 
before the cooperative organization received the amount so paid, and
    (iii) Which is determined by reference to the net earnings of the 
cooperative organization from business done with or for its patrons.

For the purpose of subdivision (ii) of this subparagraph, amounts paid 
by a cooperative organization are paid under a valid enforceable written 
obligation if such payments are required by State law or are paid 
pursuant to provisions of the bylaws, articles of incorporation, or 
other written contract, whereby the organization is obligated to make 
such payment. The term net earnings, for purposes of subdivision (iii) 
of this subparagraph, includes the excess of amounts retained (or 
assessed) by the organization to cover expenses or other items over the 
amount of such expenses or other items. For purposes of such subdivision 
(iii), net earnings shall not be reduced by any taxes imposed by 
subtitle A of the Code, but shall be reduced by dividends paid on 
capital stock or other proprietary capital interests.
    (2) Exceptions. The term patronage dividend does not include the 
following:
    (i) An amount paid to a patron by a cooperative organization to the 
extent that such amount is paid out of earnings not derived from 
business done with or for patrons.
    (ii) An amount paid to a patron by a cooperative organization to the 
extent that such amount is paid out of earnings from business done with 
or for other patrons to whom no amounts are paid, or to whom smaller 
amounts are paid, with respect to substantially

[[Page 797]]

identical transactions. Thus, if a cooperative organization does not pay 
any patronage dividends to nonmembers, any portion of the amounts paid 
to members which is out of net earnings from patronage with nonmembers, 
and which would have been paid to the nonmembers if all patrons were 
treated alike, is not a patronage dividend.
    (iii) An amount paid to a patron by a cooperative organization to 
the extent that such amount is paid in redemption of capital stock, or 
in redemption or satisfaction of certificates of indebtedness, revolving 
fund certificates, retain certificates, letters of advice, or other 
similar documents, even if such documents were originally paid as 
patronage dividends.
    (iv) An amount paid to a patron by a cooperative organization to the 
extent that such amount is fixed without reference to the net earnings 
of the cooperative organization from business done with or for its 
patrons.
    (3) Examples. The application of subparagraphs (1) and (2) of this 
paragraph may be illustrated by the following examples:

    Example 1. (i) Cooperative A, a marketing association operating on a 
pooling basis, receives the products of patron W on January 5, 1964. On 
the same day cooperative A advances to W 45 cents per unit for the 
products so delivered and allocates to him a retain certificate having a 
face value calculated at the rate of 5 cents per unit. During the 
operation of the pool, and before substantially all the products in the 
pool are disposed of, cooperative A advances to W an additional 40 cents 
per unit, the amount being determined by reference to the market price 
of the products sold and the anticipated price of the unsold products. 
At the close of the pool on November 10, 1964, cooperative A determines 
the excess of its receipts over the sum of its expenses and its previous 
advances to patrons, and allocates to W an additional 3 cents per unit 
and shares of the capital stock of A having an aggregate stated dollar 
amount calculated at the rate of 2 cents per unit. Under the provisions 
of section 1382(e), W's patronage is deemed to occur in 1964, the year 
in which the pool is closed.
    (ii) The patronage dividend paid to W during 1964 amounts to 5 cents 
per unit, consisting of the aggregate of the following per-unit 
allocations: The amount of the cash distribution (3 cents), and the 
stated dollar amount of the capital stock of A (2 cents), which are 
fixed with reference to the net earnings of A. The amount of the two 
distributions in cash (85 cents) and the face amount of the retain 
certificate (5 cents), which are fixed without reference to the net 
earnings of A, do not constitute patronage dividends.
    Example 2. Cooperative B, a marketing association operating on a 
pooling basis, receives the products of patron X on March 5, 1964. On 
the same day cooperative B pays to X $1.00 per unit for such products, 
this amount being determined by reference to the market price of the 
product when received, and issues to him a participation certificate 
having no face value but which entitles X on the close of the pool to 
the proceeds derived from the sale of his products less the previous 
payment of $1.00 and the expenses and other charges attributable to such 
products. On March 5, 1967, cooperative B, having sold the products in 
the pool, having deducted the previous payments for such products, and 
having determined the expenses and other charges of the pool pays to X, 
in cash, 10 cents per unit pursuant to the participation certificate. 
Under the provisions of section 1382(e), X's patronage is deemed to 
occur in 1967, the year in which the pool is closed. The payment made to 
X during 1967, amounting to 10 cents per unit, is a patronage dividend. 
Neither the payment to X in 1964 of $1.00 nor the issuance to him of the 
participation certificate in that year constitutes a patronage dividend.
    Example 3. Cooperative C, a purchasing association, obtains supplies 
for patron Y on May 1, 1964, and receives in return therefor $100. On 
February 1, 1965, cooperative C, having determined the excess of its 
receipts over its costs and expenses, pays to Y a cash distribution of 
$1.00 and a revolving fund certificate with a stated dollar amount of 
$1.00. The amount of patronage dividend paid to Y in 1965 is $2.00, the 
aggregate of the cash distribution ($1.00) and the stated dollar amount 
of the revolving fund certificate ($1.00).
    Example 4. Cooperative D, a service association, sells the products 
of members on a fee basis. It receives the products of patron Z under an 
agreement not to pool his products with those of other members, to sell 
his products, and to deliver to him the proceeds of the sale. Patron Z 
makes payments to cooperative D during 1964 aggregating $75 for service 
rendered him by cooperative D during that year. On May 15, 1965, 
cooperative D, having determined the excess of its receipts over its 
costs and expenses, pays to Z a cash distribution of $2.00. Such amount 
is a patronage dividend paid by cooperative D during 1965.

    (b) Written notice of allocation. The term written notice of 
allocation means any capital stock, revolving fund certificate, retain 
certificate, certificate of indebtedness, letter of advice, or

[[Page 798]]

other written notice, which discloses to the patron the stated dollar 
amount allocated to him on the books of the cooperative organization, 
and the portion thereof, if any, which constitutes a patronage dividend. 
Thus, a mere credit to the account of a patron on the books of the 
organization without disclosure to the patron, is not a written notice 
of allocation. A written notice of allocation may disclose to the patron 
the amount of the allocation which constitutes a patronage dividend 
either as a dollar amount or as a percentage of the stated dollar amount 
of the written notice of allocation.
    (c) Qualified written notice of allocation--(1) In general. The term 
qualified written notice of allocation means a written notice of 
allocation:
    (i) Which meets the requirements of subparagraphs (2) or (3) of this 
paragraph, and
    (ii) Which is paid as part of a patronage dividend, or as part of a 
payment by a cooperative association organized and operated in 
compliance with the provisions of section 521 and Sec. 1.521-1 to 
patrons on a patronage basis with respect to earnings derived from 
business done with or for the United States or any of its agencies or 
from sources other than patronage, that also includes a payment in money 
or by qualified check equal to at least 20 percent of such patronage 
dividend or such payment.

In determining, for purposes of subdivision (ii) of this subparagraph, 
whether 20 percent of a patronage dividend or a payment with respect to 
nonpatronage earnings is paid in money or by qualified check, any 
portion of such dividend or payment which is paid in nonqualified 
written notices of allocation may be disregarded. Thus, if a cooperative 
pays a patronage dividend of $100 in the form of a nonqualified written 
notice of allocation with a stated dollar amount of $50, a written 
notice of allocation with a stated dollar amount of $40, and money in 
the amount of $10, the written notice of allocation with a stated dollar 
amount of $40 will constitute a qualified written notice of allocation 
if it meets the requirements of subparagraph (2) or (3) of this 
paragraph. A payment in money, as that term is used in subdivision (ii) 
of this subparagraph, includes a payment by a check drawn on a bank but 
does not include a credit against amounts owed by the patron to the 
cooperative organization, a credit against the purchase price of a share 
of stock or of a membership in such organization, nor does it include a 
payment by means of a document redeemable by such organization for 
money.
    (2) Written notice of allocation redeemable in cash. The term 
qualified written notice of allocation includes a written notice of 
allocation which meets the requirement of subparagraph (1)(ii) of this 
paragraph and which may be redeemed in cash at its stated dollar amount 
at any time within a period beginning on the date such written notice of 
allocation is paid and ending not earlier than 90 days from such date, 
but only if the distributee receives written notice of the right of 
redemption at the time he receives such written notice of allocation. 
The written notice of the right of redemption referred to in the 
preceding sentence shall be given separately to each patron. Thus, a 
written notice of the right of redemption which is published in a 
newspaper or posted at the cooperative's place of business would not be 
sufficient to qualify a written notice of allocation which is otherwise 
described in this subparagraph.
    (3) Consent of patron. The term qualified written notice of 
allocation also includes written notice of allocation which meets the 
requirement of subparagraph (1)(ii) of this paragraph and which the 
distributee has consented, in a manner provided in this subparagraph, to 
take into account at its stated dollar amount as provided in section 
1385 and Sec. 1.1385-1.
    (i) Consent in writing. A distributee may consent to take the stated 
dollar amount of written notices of allocation into account under 
section 1385 by signing and furnishing a written consent to the 
cooperative organization. No special form is required for the written 
consent so long as the document on which it is made clearly discloses 
the terms of the consent. Thus, the written consent may be made on a

[[Page 799]]

signed invoice, sales slip, delivery ticket, marketing agreement, or 
other document, on which appears the appropriate consent. Unless the 
written consent specifically provides to the contrary, it shall be 
effective with respect to all patronage occurring during the taxable 
year of the cooperative organization in which such consent is received 
by such organization and, unless revoked under section 1388(c)(3)(B), 
for all subsequent taxable years. Section 1388(c)(3)(B)(i) provides that 
a written consent may be revoked by the patron at any time. Thus, any 
written consent which is, by its terms, irrevocable is not a consent 
that would qualify a written notice of allocation. A revocation, to be 
effective, must be in writing, signed by the patron, and furnished to 
the cooperative organization. Such a revocation shall be effective only 
with respect to patronage occurring after the close of the taxable year 
of the cooperative organization during which the revocation is filed 
with it. In the case of a pooling arrangement described in section 
1382(e) and Sec. 1.1382-5, a written consent which is made at any time 
before the close of the taxable year of the cooperative organization 
during which the pool closes shall be effective with respect to all 
patronage under that pool. In addition, any subsequent revocation of 
such consent by the patron will not be effective for that pool or any 
other pool with respect to which he has been a patron before such 
revocation.
    (ii) Consent by membership. (a) A distributee may consent to take 
the stated dollar amount of written notices of allocation into account 
under section 1385 by obtaining or retaining membership in the 
cooperative organization after such organization has adopted a valid 
bylaw providing that membership in such cooperative organization 
constitutes such consent, but such consent shall take effect only after 
the distributee has received a written notification of the adoption of 
the bylaw provision and a copy of such bylaw. The bylaw must have been 
adopted by the cooperative organization after October 16, 1962, and must 
contain a clear statement that membership in the cooperative 
organization constitutes the prescribed consent. The written 
notification from the cooperative organization must inform the patron 
that this bylaw has been adopted and of its significance. The 
notification and copy of the bylaw shall be given separately to each 
member (or prospective member); thus, a written notice and copy of the 
bylaw which are published in a newspaper or posted at the cooperative's 
place of business are not sufficient to qualify a written notice of 
allocation under this subdivision. A member (or prospective member) is 
presumed to have received the notification and copy of the bylaw if they 
were sent to his last known address by ordinary mail. A prospective 
member must receive the notification and copy of the bylaw before he 
becomes a member of the organization in order to have his membership in 
the organization constitute consent. A consent made in the manner 
described in this subdivision shall be effective only with respect to 
patronage occurring after the patron has received a copy of the bylaw 
and the prerequisite notice and while he is a member of the 
organization. Thus, any such consent shall not be effective with respect 
to any patronage occurring after the patron ceases to be a member of the 
cooperative organization or after the bylaw provision is repealed by 
such organization. In the case of a pooling arrangement described in 
section 1382(e) and Sec. 1.1382-5, a consent made under this 
subdivision will be effective only with respect to the patron's actual 
patronage occurring after he receives the notification and copy of the 
bylaw and while he is a member of the cooperative organization. Thus 
such a consent shall not be effective with respect to any patronage 
under a pool after the patron ceases to be a member of the cooperative 
organization or after the bylaw provisions is repealed by the 
organization.
    (b) The following is an example of a bylaw provision which would 
meet the requirements prescribed in (a) of this subdivision.

    Example: Each person who hereafter applies for and is accepted to 
membership in this cooperative and each member of this cooperative on 
the effective date of this bylaw who continues as a member after such 
date shall, by such act alone, consent that the amount of any 
distributions with respect to his patronage occurring after ----------, 
which are

[[Page 800]]

made in written notices of allocation (as defined in 26 U.S.C. 1388) and 
which are received by him from the cooperative, will be taken into 
account by him at their stated dollar amounts in the manner provided in 
26 U.S.C. 1385(a) in the taxable year in which such written notices of 
allocation are received by him.

    (c) For purposes of this subdivision the term member means a person 
who is entitled to participate in the management of the cooperative 
organization.
    (iii) Consent by qualified check. (a) A distributee may consent to 
take the stated dollar amount of a written notice of allocation into 
account under section 1385 by endorsing and cashing a qualified check 
which is paid as a part of the same patronage dividend or payment 
described in subparagraph (1)(ii) of this paragraph of which the written 
notice of allocation is also a part. In order to constitute an effective 
consent under this subdivision, however, the qualified check must be 
endorsed and cashed by the payee on or before the ninetieth day after 
the close of the payment period for the taxable year of the cooperative 
organization with respect to which the patronage dividend or payment is 
paid (or on or before such earlier day as may be prescribed by the 
cooperative organization). The endorsing and cashing of a qualified 
check shall be considered a consent only with respect to written notices 
of allocation which are part of the same patronage dividend or payment 
as the qualified check and for which a consent under subdivision (i) or 
(ii) of this subparagraph is not in effect. A qualified check is 
presumed to be endorsed and cashed within the 90-day period if the 
earliest bank endorsement which appears thereon bears a date no later 
than 3 days after the end of such 90-day period (excluding Saturdays, 
Sundays, and legal holidays).
    (b) The term qualified check means a check, or other instrument 
redeemable in money, which is paid as a part of a patronage dividend or 
payment described in subparagraph (1)(ii) of this paragraph, on which 
there is clearly imprinted a statement that the endorsement and cashing 
of the check or other instrument constitutes the consent of the payee to 
take into account, as provided in the Federal income tax laws, the 
stated dollar amount of any written notices of allocation which are paid 
as a part of the patronage dividend or payment of which such check or 
other instrument is also a part. A qualified check need not be in the 
form of an ordinary check which is payable through the banking system. 
It may, for example, be in the form of an instrument which is redeemable 
in money by the cooperative organization. The term qualified check does 
not include a check or other instrument paid as part of a patronage 
dividend or payment with respect to which a consent under subdivision 
(i) or (ii) of this subparagraph is in effect. In addition, the term 
qualified check does not include a check or other instrument which is 
paid as part of a patronage dividend or payment, if such patronage 
dividend or payment does not also include a written notice of allocation 
(other than a written notice of allocation that may be redeemed in cash 
at its stated dollar amount which meets the requirements of section 
1388(c)(1)(A) and subparagraph (2) of this paragraph). Thus, a check 
which is paid as part of a patronage dividend is not a qualified check 
(even though it has the required statement imprinted on it) if the 
remaining portion of such patronage dividend is paid in cash or if the 
only written notices of allocation included in the payment are qualified 
under section 1388(c)(1)(A) and subparagraph (2) of this paragraph 
(relating to certain written notices of allocation which are redeemable 
by the patron within a period of at least 90 days).
    (c) The provisions of this subdivision may be illustrated by the 
following example.

    Example: (1) The A Cooperative is a cooperative organization filing 
its income tax returns on a calendar year basis. None of its patrons 
have consented in the manner prescribed in section 1388(c)(2) (A) or 
(B). On August 1, 1964, the A Cooperative pays patronage dividends to 
its patrons with respect to their 1963 patronage, and the payment to 
each such patron is partly by a qualified check and partly in the form 
of a written notice of allocation which is not redeemable for cash. Each 
patron who endorses and cashes his qualified check on or before December 
14, 1964 (the ninetieth day following the close of the 1963 payment 
period) shall be considered to have consented with respect to the 
accompanying written notice of allocation and the amount of such check 
is treated

[[Page 801]]

as a patronage dividend paid in money on August 1, 1964.
    (2) As to any patron who has not endorsed and cashed his qualified 
check by December 14, 1964, there is no consent and both the written 
notice of allocation and the qualified check constitute nonqualified 
written notices of allocation within the meaning of section 1388(d) and 
paragraph (d) of this section. If such a patron then cashes his check on 
January 2, 1965, he shall treat the amount received as an amount 
received on January 2, 1965, in redemption of a nonqualified written 
notice of allocation. Likewise, the cooperative shall treat the amount 
of the check as an amount paid on January 2, 1965, in redemption of a 
nonqualified written notice of allocation.

    (d) Nonqualified written notice of allocation. The term nonqualified 
written notice of allocation means a written notice of allocation which 
is not a qualified written notice of allocation described in section 
1388(c) and paragraph (c) of this section, or a qualified check which is 
not cashed on or before the ninetieth day after the close of the payment 
period for the taxable year of the cooperative organization for which 
the payment of which it is a part is paid.
    (e) Patron. The term patron includes any person with whom or for 
whom the cooperative association does business on a cooperative basis, 
whether a member or a nonmember of the cooperative association, and 
whether an individual, a trust, estate, partnership, company, 
corporation, or cooperative association.

[T.D. 6643, 28 FR 3160, Apr. 2, 1963]