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501(c)12 Information


Rural Electric Cooperatives such as Anza Electric Cooperative are typically structured as 501(c)12 organizations, which requires that they be organized and operated as mutual or cooperative organizations. The following are select sections from the IRS rules for 501(c)12 organizations:

IRS Requirements for Cooperative Electric Companies


1.    Ditch and irrigation companies, telephone companies, electric companies, and “like organizations” that seek exemption under IRC 501(c)(12) must be organized and operated as mutual or cooperative organizations. The terms “mutual” and “cooperative” have no legal distinction for purposes of section 501(c)(12). The U.S. Tax Court defined “cooperative” as follows:
“A cooperative is an organization established by individuals to provide themselves with goods and services or to produce and dispose of the products of their labor. The means of production and distribution are those owned in common and the earnings revert to the members, not on the basis of their investment in the enterprise, but in proportion to their patronage or personal participation in it.”

2.    The organizational and operational cooperative principles are as follows:

1.     Democratic Control. The organization must periodically hold democratically conducted meetings with members. Election of officers must be on a one member, one vote basis. Meetings must have a quorum of members in attendance or voting by proxy.

2.     Operation at Cost. The organization must allocate all excess operating revenues (excess of revenue over expenses) among the members.

3.     Subordination of Capital. The organization must ensure that those who contribute capital neither control the operations nor receive most of the pecuniary benefits. The organization will meet this requirement by ensuring that the members control and own the savings or monetary benefits rather than the shareholders or equity investors.

The Service sets out additional organizational and operational cooperative requirements that an organization must meet for exemption under IRC 501(c)(12). Rev. Rul. 72-36, 1972-1 C.B. 151. These requirements are:

1.    The organization must keep adequate records of each member’s rights and interests in its assets.

2.    The organization must distribute any savings to members in proportion to the amount of business done with them based on the “operation at cost” principle.

3.    The organization must not retain more funds than it needs to meet current losses and expenses.

4.    The organization cannot forfeit a member’s right and interest in the organization upon termination of membership.

5.    Upon dissolution, the organization must distribute the gains from the sale of any appreciated assets to all persons who were members during the period that the organization owned the assets, in proportion to the amount of business done by the members during that period.


The 85-Percent Member Income Test


1.    A cooperative exempt under IRC 501(c)(12) must receive 85 percent or more of its income from members. The 85-percent member income test requires that the income be

·       derived from members and

·       used to pay for services listed in IRC 501(c)(12)
Rev. Rul. 2002-55, 2002-2 C.B. 529; see Rev. Rul. 2002-54, supra, Treas. Reg. 1.501(c)(12)-1(a), and Credit Rural Electric Cooperative Corp. v. Commissioner , supra.

2.    The 85-percent member income test is computed each tax year. If in any year the member income falls below 85 percent of the total income received that year, the organization is no longer exempt under IRC 501(c)(12) for that tax year and must file a corporate tax return. Rev. Rul. 65-99, 1965-1 C.B. 242.

3.    When an organization uses the accrual method of accounting, it will use the same method to compute the 85-percent member income test. Rev. Rul. 68-18, 1968-1 C.B. 271.

4.    Electric cooperatives do not have to subtract the cost of goods sold from gross sales to calculate the 85-percent member income test. Prior to 1998, the Service’s position was that an electric cooperative must deduct the cost of goods sold for purposes of calculating the 85-percent member income test. See Rev. Rul. 80-86, 1980-1 C.B. 118. This position was proposed for formal adoption in Prop. Treas. Reg. 1.501(c)(12)-2 (49 Fed. Reg. 1244, 1984). The proposed regulation was withdrawn. See 58 Fed. Reg. 25587 (April 27, 1993). Under the safe harbor guidelines, electric cooperatives may continue to use the method they have consistently used in the past. Ann. 96-24, 1996 I.R.B. 35, (12)22.3(b).

A benevolent life insurance company is not entitled to exemption if it issues policies for stipulated cash premiums, or requires advance deposits to cover the cost of the insurance and maintains investments from which it gets more than 15 percent of its income. However, if an organization makes advance assessments for the sole purpose of meeting future losses and expenses, and retains the balance of the assessments remaining at the end of the year to meet losses and expenses or returns it to members, it may be entitled to exemption.

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