Rev. Rul. 71-439

Advice has been requested whether, under the circumstances described below, (1) amounts distributed by a nonexempt cooperative association to its member-stockholders on the basis of man-hours worked are patronage dividends as defined in section 1388(a)(1) of the Internal Revenue Code of 1954, and (2) whether gain recognized by such an association pursuant to an election under section 631(a) of the Code is income from a source other than patronage.

The taxpayer is a nonexempt cooperative association of the type commonly referred to as a "workers' cooperative association." The association is engaged in the manufacture and sale of plywood and related wood products. It owns standing timber that serves as a source of raw materials, and has elected under section 631(a) of the Code to treat the cutting of such timber as a sale or exchange of the timber. In accordance with a pre-existing obligation, the association distributes its net earnings to its member-stockholders based upon the number of man-hours worked by them for the association.

Section 1382(b)(1) of the Code provides, in part, that in determining the taxable income of a cooperative there shall not be taken into account amounts paid during the payment period for the taxable year as patronage dividends with respect to patronage occurring during such taxable year. Such amounts are treated as deductions in the Income Tax Regulations. See section 1.1382-1 of the regulations.

Section 1388(a)(1) of the Code provides that the term "patronage dividend" means an amount paid to a patron by a cooperative on the basis of quantity or value of business done with or for such patron.

In Puget Sound Plywood, Inc. v. Commissioner, 44 T.C. 305 (1965), acquiescence, C.B. 1966-1, 39, the Tax Court of the United States held that amounts distributed by a plywood producing nonexempt cooperative association to its worker-members on the basis of the number of hours worked by them qualified as patronage dividends. A similar conclusion was reached in Linnton Plywood Association v. United States, 236 F. Supp. 227 (1964).

In light of the decisions in Puget Sound Plywood and Linnton Plywood Association, it is held, in answer to the first question, that amounts distributed by the taxpayer-association to its member-stockholders on the basis of man-hours worked by such members are patronage dividends as defined in section 1388(a)(1) of the Code. If the other requirements of section 1388 of the Code and the regulations thereunder are fulfilled, such amounts are deductible from the gross income of the association to the extent provided in section 1382 of the Code.

Section 631(a) of the Code provides, in part, that a taxpayer may elect to treat the cutting of certain timber as a sale or exchange of such timber. If such an election is made, gain or loss to the taxpayer is recognized in an amount equal to the difference between the fair market value of the timber cut during the taxable year and the adjusted basis for depletion of such timber in the hands of the taxpayer. Section 1388(a) of the Code, provides, in part, that the term patronage dividend does not include any amount paid to a patron to the extent that such amount is out of earnings other than from business done with or for patrons. Section 1.1382-3(c)(2) of the regulations provides, in part, that income derived from sources other than patronage means incidental income derived from sources not directly related to the marketing, purchasing, or service activities of the cooperative association. For example, income derived from the lease of premises, from investment in securities, or from the sale or exchange of capital assets constitutes income derived from sources other than patronage.

The gain recognized by the instant taxpayer pursuant to a section 631(a) election represents the unrealized appreciation in value of timber cut during the year which, in the absence of an election under section 631(a) of the Code, would have been reflected in the taxpayer's ordinary income from the sale of wood products and be included in amounts available for patronage dividend distributions. The election permits an earlier recognition at capital gain rates of an amount that ultimately may be realized by the taxpayer when the finished product of its timber is sold. The actual realization of the appreciation in value of the standing timber (when the finished product is sold) is brought about through the cooperative efforts of the members. Accordingly, in answer to the second question, it is held that the gain recognized by the taxpayer pursuant to an election under section 631(a) of the Code is income from a patronage source.

Revenue Ruling 61-47, C.B. 1961-1, 193, which holds that amounts distributed by a nonexempt cooperative association to its member-stockholders on the basis of man-hours worked by such stockholders for the association do not constitute true patronage dividends, is hereby revoked.