A patronage dividend is a dividend or distribution that a co-operative pays to its members or investors. Patronage dividends are given based on a proportion of profit that the business makes.

Once this amount is determined, management calculates the dividend according to how much each member has used the co-op's services. Tax rules view these profits essentially as an overcharge, which can be returned to patrons and deducted from the co-op's taxable income.

Breaking Down Patronage Dividend

As the name implies, patronage dividends are paid to individuals as a result of belonging to the co-operative. One example can be seen when families purchase groceries through a co-operative 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.

Patronage Dividends and Other Forms of 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 a 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).

Start-ups 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.