1) What are the benefits of being a Farm Credit member?
One of the most important benefits of being a Farm Credit member-borrower is that you stand to share in the association's profits.
Most businesses return their profits to their investors, not their customers. However, your Farm Credit association returns its profits to its customers, or member-users. That's the cooperative way of doing business.
At the end of each fiscal year, your Farm Credit association determines its total income and expenses. Income remaining after all expenses are deducted (net income) can then be distributed in accordance with the association's bylaws.
The Board of Directors can elect to retain all of the net income to strengthen the association's capital position, or distribute a portion of, or all, of the net income to members by declaring a dividend on stock or declaring a patronage refund.
2) What is a patronage refund?
A patronage refund is a way of distributing the association's net income to its member-borrowers. A member's refund is based on the proportion of interest earned on his or her loan to the total interest earned by the association. A patronage refund may be paid in cash, allocated surplus, stock, or any combination of these items. A patronage refund is a way to refund a portion of the interest you paid on your loan.
3) How do patronage refunds benefit Farm Credit borrowers?
Patronage refunds benefit borrowers by reducing their cost of borrowing. Farm Credit charges competitive rates on its loans - rates comparable to those charged by other lenders for similar loans.
However, a major difference between Farm Credit and other lenders is that Farm Credit returns its profits to its borrowers. When you receive a patronage refund from Farm Credit, your effective cost of borrowing is reduced.
One of the basic cooperative principles is that members derive benefits based on their use of the cooperative's services. Therefore, the more business you do with Farm Credit, the larger your potential patronage refund.
4) How do patronage refunds benefit your Farm Credit association?
Patronage refunds can help Farm Credit reduce its tax expense and maintain a strong capital position. This helps the entire membership because an association with a strong capital position is better able to offer competitive interest rates, ensure a constant supply of credit and provide for the retirement of member equity held in the form of allocated surplus.
Unlike other corporations where profits are taxed twice, when earned by the corporation and when distributed to owners as dividends, a cooperative's profits are taxed only once when they are distributed as a patronage refund.
Farm Credit is allowed a tax deduction for the amount of net income that it distributes in the form of a qualified patronage refund. Therefore, to effectively manage the association's tax expense and maintain a strong capital position, the Board of Directors may elect to distribute earnings to members as a qualified patronage refund. A qualified patronage refund is one in which at least 20 percent is paid in cash and the remainder in either stock or qualified allocated surplus.
5) What is allocated surplus?
Members, through their boards, usually elect to leave a portion of the patronage refund in the cooperative to help keep its operation on a sound financial basis.
The retained portion of each member's patronage refund is recorded on the books of the association, or allocated to each member's equity account. This retained patronage refund is called allocated surplus. Allocated surplus can be either Qualified or Nonqualified.
Qualified Allocated Surplus:
Qualified Allocated Surplus is a portion of the patronage refund retained for the purpose of providing for the capital needs of your cooperative. Farm Credit operates with a minimal stock requirement. This stock requirement is not adequate to maintain the levels of capital which are required to operate a safe and sound financial institution. Allocated surplus now provides that source of capital.
Qualified Allocated Surplus can be retired only when approved by the association's board of directors. The association's goal is to operate efficiently and maintain a strong permanent capital base. It is the board's responsibility to continually monitor the financial position of the association. The board may vote to retire qualified allocated surplus when it determines the association does not need it for capital.
Qualified Allocated Surplus is issued in annual series, with each series being identified by the year in which it was issued. Similarly, allocated surplus can be retired only by series, or portions thereof. Under the bylaws, the association cannot honor requests from members to retire individual allocated surplus accounts.
The Internal Revenue Code allows your association to claim a tax deduction for a patronage distribution made in the form of Qualified Allocated Surplus in the year it is issued, as long as at least 20 percent of the total patronage refund is paid in cash. The Internal Revenue Code requires that patronage distributions in the form of Qualified Allocated Surplus be treated as taxable income to the member in the same manner as cash distributions. Association members should consult their tax advisors to determine if they must declare such patronage refunds as taxable income in the year they receive them.
Members do not have to pay tax on Qualified Allocated Surplus when it is retired since they paid tax on it when it was issued.
Nonqualified Allocated Surplus
This is another way your association can distribute its net income. Nonqualified Allocated Surplus is not deductible by your association or taxable to you in the year it is issued. Rather, members pay tax on Nonqualified Allocated Surplus only when the board of directors elects to retire it for cash. Such cash retirement would be deductible by your association.
Nonqualified Retained Surplus
This is another way your association can distribute its net income to build capital. Your association's board considers Nonqualified Retained Surplus as earnings permanently invested in the association. As such, there is no plan to revolve or redeem Nonqualified Retained Surplus. For tax purposes, Nonqualified Retained Surplus is treated the same as Nonqualified Allocated Surplus in that the amount retained will become taxable income to association members only when the board elects to retire it. However, due to its nature, it is not probable that Nonqualified Retained Surplus will be retired except upon liquidation of the association, in which case, it would be subject to distribution in accordance with the association's bylaws.
6) How is my patronage refund issued?
The cash portion of your patronage refund may be issued to you by check or recorded on the association's books in a special account.
When any portion of a patronage refund is paid in cash, your Board of Directors may elect to set a minimum check amount as a means of controlling expenses. Cash distributions below the minimum check amount are recorded in a special account called patronage payable.
Members may request a check for monies in their patronage payable accounts, request that these amounts be applied to their loans, or leave these distributions "on account" with the association.
Patronage refunds issued in the form of allocated surplus can only be retired, or paid to members, upon approval of the board. Under the bylaws, the association cannot honor requests from members to retire the individual allocated surplus accounts.
Each time a patronage distribution is issued, Farm Credit will notify eligible members of their patronage refunds. The notification will include a breakdown of the amount paid in cash (by check or patronage payable entry) and the amount paid in allocated surplus or stock.
7) Will I receive a tax notification regarding my patronage refund?
Yes. Each January, Farm Credit will send you an IRS Form 1099. This form will show the total of all taxable patronage refunds issued to you during the previous year. If a portion of a patronage refund was paid in Qualified Allocated Surplus, the 1099 will include the cash and allocated surplus portions of the patronage refund.
8) What is the bottom line on patronage refunds?
The use of patronage refunds makes a significant reduction in your effective interest cost and saves you money. The next time you sit down and write a check to another lending institution, ask yourself a question: "How much of this interest payment will the bank be returning to me?" If your answer is "none," then maybe you should consider doing more of your business where you are a stockholder - Farm Credit. Remember, you own the bank, and you share in the profits.
