Understanding Patronage Dividends: How They Work in Cooperatives

What Is a Patronage Dividend?

A patronage dividend (or refund) is a profit-based distribution a cooperative pays to members based on how much they used the co-op’s services. Unlike traditional dividends tied to shares owned, patronage dividends are tied to participation and may come as cash, credits, or reduced prices, and they can lower the co-op’s taxable income; members may need to report them for tax purposes.

Understanding the Mechanism of Patronage Dividends

A patronage dividend is essentially a refund for members who have purchased goods or services from a cooperative. As the name implies, patronage dividends are paid to individuals as a result of belonging to the cooperative. One example can be seen when families purchase groceries through a cooperative and receive income or a credit on their account in return. 

Although the U.S. government taxes these as ordinary dividend income, they may also contain an alternative minimum tax adjustment amount and are usually reported on Form 1099-PATR. Some co-ops will use the dividends to reduce the selling price of items; thus, in a way, the more members spend, the more they receive.

Important Tax Considerations for Patronage Dividends

Patronage dividends—reported on IRS Form 1099-PATR—can be deducted from gross income for tax purposes. In some cases, the patron receiving the dividend can deduct it from their personal returns. Cooperatives can issue stock dividends, but that is very rare. 

To be used to reduce taxable income, a cooperative must pay the patronage dividend based on the use of services or products purchased. As well, the cooperative must commit to paying out such a dividend before receiving the income from which the dividend will be paid.

Comparing Patronage Dividends to Traditional Dividends

Patronage dividends are just one of several forms of dividends, beginning with traditional dividends. These are distributions of a portion of a company’s earnings, issued as cash payments, shares of stock, or other property. A company’s board of directors announces the record date for traditional dividends, determines the class of shareholders who will receive the distribution, and the payout policy (e.g., stable, target payout ratio, constant payout ratio, and a residual dividend model).

Startups and other high-growth companies rarely offer dividends, preferring instead to reinvest any profits to help sustain higher-than-average growth. Larger, established companies with more predictable profits are often the best dividend payers, such as those in basic materials, oil and gas, banks and financial, healthcare and pharmaceuticals, and utilities.

Special dividends or extra dividends are non-recurring distributions of company assets. These usually occur after exceptionally strong company earnings results or when a company wishes to spin off a subsidiary company to its shareholders.

A capital dividend or return of capital is a payment that a company makes to its investors. Capital dividends are drawn from a company’s paid-in-capital or shareholders’ equity, rather than from the company’s earnings as with traditional dividends. Capital dividends generally occur in instances where company earnings cannot facilitate cash payment. Capital dividends can be destructive as they deplete the company’s capital base, limiting potential future investment and business opportunities.

The Bottom Line

Patronage dividends are based on a member’s use of a co-op, not shares owned, and can reduce the co-op’s taxable income if conditions are met, including deciding on the payout before the related income is received. For members, they may be taxable and reported on IRS Form 1099-PATR. As an example, a grocery co-op might issue an account credit or cash refund tied to purchases.