IRS written determination 202613002

Private letter rulings and published taxpayer determination letters. Native document type is retained separately; a determination letter is not labeled a private letter ruling. These taxpayer-specific releases cannot be used or cited as precedent under 26 USC 6110(k)(3); applicability and current legal force are not independently certified. Keep repeated UILC subjects attached to one actual numbered document.

Internal Revenue Service
Department of the Treasury
Washington, DC 20224
Number: 202613002
Release Date: 3/27/2026
Index Number: 1382.02-00, 1388.00-00

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In Re:
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Third Party Communication: None
Date of Communication: Not Applicable
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:ECE:01
PLR-103331-21
Date:
December 22, 2025

LEGEND

Cooperative = -------------------------------------------------------------------------------------------
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Sub = -------------------------------------------------------------------------------------------
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Z = ---
P = -------------------------------------
Buyer = -------------------------------------------------
Area = -------------------------------------------------------------------------------------------
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Date 1 = -----------------------
Date 2 = -----------------------

Dear -------------:

This letter responds to a request for a private letter ruling, dated Date 1, and
subsequent correspondence, submitted on behalf of Cooperative by its authorized
representatives, regarding the application of cooperative tax law to the transaction
described below.

FACTS

Cooperative is a rural telephone cooperative corporation operating on a
cooperative basis. Cooperative’s bylaws require it to allocate patronage earnings
among its patrons on a patronage basis.

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Section 501(c)(12) of the Code contemplates that rural telephone cooperatives
may qualify as tax-exempt organizations. As the telephone business has developed,
however, very few rural telephone cooperatives, including Cooperative, qualify for this
exemption. Therefore, Cooperative is a taxable cooperative corporation.

Cooperative is the parent of an affiliated group that files a consolidated federal
income tax return using a December 31 year end and the accrual method of accounting.
Cooperative owns all the stock of Sub.

Cooperative provides telecommunications services to its members (patrons) and
to nonmember customers in the rural area it serves, including telecommunications
exchange and local access services, long distance services, internet services, video
services, wireless communications, and telecommunications equipment sales. As a
provider of telecommunications services, Cooperative is subject to federal, state, and
local regulations. To assist Cooperative in complying with applicable regulations, Sub
holds nonregulated telecommunications assets for the benefit of Cooperative and in
furtherance of Cooperative’s telecommunications services.

Prior to Date 2, Sub owned a Z percent partnership interest in P, a partnership
for federal income tax purposes. Prior to Date 2, P owned, operated, and maintained a
cellular network and provided cellular telecommunications services in Area. Prior to
Date 2, Cooperative used P’s cellular network to provide cellular telecommunication
services to its patrons and other customers in the rural area it serves.

On Date 2, Sub sold its Z percent partnership interest in P to Buyer, and P
dissolved. Cooperative will use the sale proceeds to build out its local exchange
networks, improve services to its patrons and other customers, and focus on its core
mission of bringing state of the art telecommunications services to businesses and
residents in the rural area it serves.

RULING REQUESTED

Cooperative requests a ruling that the portion of Sub’s gain from the sale of its
interest in P that is allocable to Cooperative’s patrons use of P’s network constitutes
patronage-sourced income and, if that proportion of gain is properly allocated to
Cooperative’s patrons, is excludable from Cooperative’s consolidated gross income in
the taxable year of the sale.

LAW AND ANALYSIS

In the event a rural telephone cooperative such as Taxpayer loses its tax-exempt
status, section 501(c)(12) no longer applies until such time as the cooperative again
satisfies the requirements for exemption. During any taxable period, the rules
applicable to the telephone cooperative depend on the reasons why it failed its
exemption test. If exemption was lost because the company failed to operate on a
cooperative basis, then it will be taxed under the same rules applicable to for-profit

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corporations. Alternatively, if the cooperative becomes taxable because it failed the so-
called 85-percent-income test imposed by section 501(c)(12), then the organization will
be taxed as a cooperative.

While the requirements of subchapter C of the Code regarding corporate
distributions and adjustments and other provisions are generally applicable to
nonexempt cooperatives, these entities are distinguished from other types of
corporations by a specific body of tax law. The scheme of taxation for nonexempt
cooperatives was developed from the administrative pronouncements of the Service
and decisions of the judiciary over a fifty-year period. These rules for tax treatment of
most nonexempt cooperatives and their patrons were finally codified with the enactment
Subchapter T of the Code as part of the Revenue Act of 1962. Pub. L. No. 87-834
(H.R. 10650).

With passage of Subchapter T, the rules for deduction of patronage dividends
and the treatment of patronage dividends in the hands of a cooperative's patrons were
defined. However, section 1381(a)(2)(C) of the Code states that Subchapter T is not
applicable to an organization engaged in furnishing electric energy or providing
telephone service to persons in rural areas. According to the Senate Finance
Committee Report accompanying the 1962 Act, the intent of Congress was that
nonexempt rural electric and telephone cooperatives would continue to be treated as
under “present law.”

In its report accompanying the legislation, the Senate Finance Committee
described “present law” as follows:

Under present law patronage dividends paid by taxable cooperatives result in a
reduction in the cooperative's taxable income only if they are paid during the
taxable year in which the patronage occurred or within the period in the next year
elapsing before the prior year's income tax return is required to be filed (including
any extensions of time granted).

S. Rep. No. 1881, 87th Cong., 1st Sess. 113 (1962).

Under this earlier body of tax law applicable to nonexempt telephone
cooperatives, a cooperative may reduce its taxable income by any qualifying patronage
dividends paid to their members/patrons. Further, under pre-1962 cooperative rules,
the term “paid” means paid in cash or paid by notice of allocation. See also Rev. Rul.
83-135, 1983-2 C.B. 149 (A taxable cooperative not subject to the provisions of
subchapter T may exclude from gross income the patronage dividends paid or allocated
to its patrons in accordance with its by-laws).

While Subchapter T does not control the taxation of nonexempt telephone
cooperatives, its foundations rest upon pre-1962 cooperative tax law. As a result, there
are certain basic parallels between the tax treatment of nonexempt utility cooperatives

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and the treatment of other cooperative organizations under Subchapter T. Therefore, to
the extent that Subchapter T reflects cooperative taxation as it existed prior to 1962, it is
instructive in resolving certain issues facing rural telephone cooperatives. This is
because Congress stated that in enacting Subchapter T it was merely codifying the
long, common law history of cooperative taxation (with the exception of ensuring at least
one annual level of tax at the cooperative or patron level. See S. Rep. No. 1881, 87
th

Cong., 1
st
Sess. 113 (1962)) and, arguably, the case law post-enactment is merely a
continuation and refinement of the pre-enactment common law. This is particularly true
with respect to defining certain terms such as “operating on a cooperative basis” and
“patronage income.”

Perhaps the most succinct definition of the term “cooperative” for Federal income
tax purposes was provided by the U.S. Tax Court in Puget Sound Plywood, Inc. v.
Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B. 3. The Tax Court stated:

Under the cooperative association form of organization, on the other hand, the
worker-members of the association supply their own capital at their own risk;
select their own management and supply their own direction for the enterprise,
through worker meetings conducted on a democratic basis; and then themselves
receive the fruits of their cooperative endeavors, through allocations of the same
among themselves as coworkers, in proportion to the amounts of their active
participation in the cooperative undertaking.

The Tax Court went on to describe three guiding principles at the core of economic
cooperative theory as:

(1) Subordination of capital, both as regards control over the cooperative
undertaking, and as regards the ownership of the pecuniary benefits arising
therefrom; (2) democratic control by the worker-members themselves; and,
(3) the vesting in and allocation among the worker-members of all fruits and
increases arising from their cooperative endeavor (i.e., the excess of operating
revenues over the costs incurred in generating those revenues), in proportion to
the worker-members active participation in the cooperative endeavor.

44 T.C. at 308.

The mechanism by which cooperatives achieve operation at cost is the
patronage dividend (or capital credit). Because the payment of patronage dividends
(and operation at cost) is so critical to achieving cooperative status as defined by Puget
Sound, it is important to analyze this issue.

Rural telephone cooperatives perform a final accounting at year-end to determine
the net margin derived from their members' patronage during the course of the year.
Then, the excess over cost collected from members is returned to them by a capital
credit allocation based on each member's patronage. Those capital credits are typically

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“paid” by allocations of capital credit certificates or notices of allocation, rather than in
cash. The capital credits retained form the foundation for the organization's equity
capital.

A true patronage dividend that may be excluded from the income of a nonexempt
rural telephone cooperative must meet the three tests set forth in Farmers Cooperative
Co. v. Birmingham, 86 F. Supp. 201 (N.D. Ia. 1949), and Pomeroy Cooperative Grain
Co. v. Commissioner, 31 T.C. 674 (1958), acq., AOD 1959-2 C.B. 6. Those tests are:

1. It must be made subject to a preexisting legal obligation;

2. the allocation must be made on the basis of patronage; and

3. the margins allocated must be derived from the profits generated from patrons'
dealings with the cooperative.

Although the Code does not provide specific guidance as to what constitutes
patronage-sourced income for a nonexempt rural telephone cooperative, regulations
and rulings address the issues for cooperatives governed by Subchapter T. While not
directly applicable to nonexempt utility cooperatives per se, arguably they reflect the
correct analysis with respect to patronage income of cooperatives subject to pre-1962
law.

The Senate Committee Report accompanying the cooperative provisions in the
Revenue Act of 1951 indicated that Congress intended to tax “ordinary” (i.e., non-
farmer) cooperatives for their “non-operating income ... not derived from patronage, as
for example in the case of interest or rental income, even if distributed to patrons on a
pro rata basis.” S. Rep. No. 781, 82d Cong. 1
st
Sess. (1951).

In response to that guidance of Congress, the Service promulgated regulations
distinguishing nonpatronage income from that which is patronage derived.

Section 1388(a) of the Code defines the term “patronage dividend” as an amount
paid to a patron (1) on the basis of quantity or value of business done with or for such
patron, (2) under an obligation of such organization to pay such amount, which
obligation existed before the organization received the amount so paid, and (3) which is
determined by reference to the net earnings of the organization from business done with
or for its patrons. Such term does not include any amount paid to a patron to the extent
that (A) such amount is out of earnings other than from business done with or for
patrons, or (B) such amount is 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 identical transactions. The (B) exception is further explained
under Section 1.1388-1(a)(2)(ii) of the Income Tax Regulations:

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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 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.

In Rev. Rul. 69-576, 1962-2 C.B. 166, the taxpayer (a nonexempt farmers'
cooperative) borrowed money from a bank for cooperatives to finance the acquisition of
agricultural supplies for resale to its members. At the close of the taxable year for the
bank, the bank determined its net earnings, which it then allocated to its patrons,
including the nonexempt farmers' cooperative, on a patronage basis. The patronage
allocations were based on the proportion of the total interest paid to it by each
cooperative during the taxable year. The nonexempt farmers' cooperative included the
patronage allocations received by it from the bank for cooperatives in its gross income
for the taxable year received under section 1385 of the Code. Under a preexisting
obligation, the nonexempt farmers' cooperative then allocated and paid the
same amount it received from the bank for cooperatives to its own patrons. Rev. Rul.
69-576 held that the allocation and payment of the amount by the nonexempt farmers’
cooperative to its own patrons qualified as a patronage dividend. Rev. Rul. 69-576
stated that:

The classification of an item as from either patronage or non-patronage sources
is dependent on the relationship of the activity generating the income to the
marketing, purchasing, or service activities of the cooperative. If the income is
produced by a transaction which actually facilitates the accomplishment of the
cooperative's marketing, purchasing, or servicing activities, the income is from
patronage sources.

In Farmland Industries, Inc. v. Commissioner, 78 T.C.M. 846, 864 (1999), acq.,
AOD 2001-03, a cooperative organized for the purpose of providing petroleum products
to its patrons sought to have the proceeds from the disposition of its stock in three
subsidiaries, along with the income from the sale of its gas and soybean facilities, and
miscellaneous depreciable business assets classified as patronage source. In
articulating the “directly related” test for making the determination, the Tax Court stated
that if the income at issue is produced by a transaction which is directly related to the
cooperative enterprise, such that the transaction facilitates the cooperative’s marketing,
purchasing, or service activities, then the income is deemed to be patronage income.
On the other hand, if the income is derived from a transaction that has no integral and
necessary linkage to the cooperative enterprise, such that it may fairly be said that the
income is merely incidental to the cooperative enterprise and does nothing more than
add to the overall profitability of the cooperative, then the income is deemed to be
nonpatronage income. The determination of whether income derived from a transaction

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is directly related to the cooperative enterprise and, thus, is patronage income is a
determination that is necessarily fact intensive. In considering the relatedness of the
income-producing transaction to the cooperative enterprise, it is important to focus on
the “totality of the circumstances” and to view the business environment to which the
income-producing transaction is related and not to view the transaction so narrowly as
to limit it only to its income-generating characteristic when such a characterization is not
consistent with the actual activity. The Tax Court held that the sale of cooperative’s
assets met the directly related test and therefore the resultant gains and losses were
patronage sourced.

Section 1.1388-1(e) defines patron to include any person with whom or for whom
the cooperative association does business on a cooperative basis.

CONCLUSION

Sub’s ownership of its partnership interest in P was directly related to the
cooperative business purpose of Cooperative. The telecommunications services
provided by P were directly related to the cooperative business purpose of Cooperative
whose "reason for existence” is to provide telecommunications services to its members.
Sub’s sale of its partnership interest in P was directly related to the cooperative
business purpose of Cooperative. Cooperative will use the sales proceeds to build out
its local exchange networks, improve services to its members and other customers, and
focus on its core mission of bringing state of the art telecommunications services to
businesses and residents in the rural area it serves.

Based on consideration of Taxpayer’s representations, because P was used to
provide telecommunication services to Cooperative’s patrons, the sale of Sub’s
partnership interest in P satisfies the directly related test, and the portion of gain that is
allocable to Cooperative’s patrons use of P’s network is patronage sourced income.

Accordingly, based on the facts submitted and the representations made, we rule
that the patron portion of Sub’s gain from the sale of its partnership interest in P
constitutes patronage-sourced income and, if properly allocated to Cooperative’s
patrons, is excludable from Cooperative’s consolidated gross income in the taxable year
of the sale.

Except as expressly provided herein, no opinion is expressed or implied
regarding the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. In particular, no opinion is expressed or implied regarding the
effect on the patrons of the transaction.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for ruling, it is subject to verification on examination.

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This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this
letter is being sent to your authorized representatives.

Sincerely,

NICOLE R. CIMINO
Chief, Branch 1
Office of the Associate Chief Counsel
(Energy, Credits, & Excise Tax)

Enclosure:
Copy of this letter for § 6110 purposes

CC: -----------------------------
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