What Is a Patronage Dividend and How Do They Work?

What Is a Patronage Dividend?

A patronage dividend, also known as a patronage refund, is a distribution that a cooperative 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.

Key Takeaways

  • Patronage dividends are those distributions of profits paid by a co-operative to their owners.
  • Patronage dividends are paid based on a portion of the profit the business makes.
  • The exact dividend each member receives is based on how much they used the co-op’s services or how much in products they purchased. 
  • Patronage dividends can be used to reduce taxable income for cooperatives if they meet certain criteria.

How a Patronage Dividend Works

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.

Special Considerations

Patronage dividends 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.

Patronage Dividends vs. Other 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.

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