Comment letters submitted by advocacy groups to the Department of the Treasury (Treasury) and the IRS on its 2024–2025 Priority Guidance Plan could provide an opportunity for taxpayers who are patrons of credit cooperatives to reduce borrowing costs if addressed.
The comment letters request guidance be issued to provide a patron may net a patronage dividend received with the associated business interest expense paid to a credit cooperative for purposes of Internal Revenue Code (IRC) Section 163(j). The tax law authorities cited for this requested guidance are twofold:
- Based on the conduit treatment for regulated investment companies (RICs) as provided in the Section 163(j) regulations, noting a similar judicial conduit treatment for patronage dividends of cooperatives.
- Under the established legislative and judicial theory of a patronage dividend functioning as a price adjustment or rebate on the business interest expense paid.
The National Council of Farmer Cooperatives (NCFC) and National Society of Accountants for Cooperatives (NSAC) both submitted comment letters on May 30, 2024, requesting the Treasury and IRS issue guidance with respect to the treatment of patronage dividends received by a patron with business interest expense subject to Section 163(j) generated by debt financing issued by a credit cooperative.
If addressed, the guidance from the Treasury and IRS could potentially benefit many farmers, fishers, and rural agribusinesses who rely on credit cooperatives for financing, and in many instances, these credit cooperatives are the only available source of financing.
Who Is Affected by the Priority Guidance Plan?
A taxpayer patron subject to Section 163(j), which may be an individual or entity taxed as a partnership, S Corporation, C Corporation, or cooperative, becomes a patron of a credit cooperative for purposes of executing a loan agreement for interest-bearing financing issued by the credit cooperative.
For example, the credit cooperative may be a member of the Farm Credit System, such as CoBank or an Agricultural Credit Association, regulated by the Federal Farm Credit Administration.
Background on IRS Notice
IRS Notice 2024-28 invited the public to submit recommendations by May 31, 2024, for items to be included in the 2024–2025 Priority Guidance Plan.
The Treasury Department's Office of Tax Policy and the IRS use the Priority Guidance Plan each year to identify and prioritize the tax issues that should be addressed through regulations, revenue rulings, revenue procedures, notices, and other published administrative guidance.
The 2024-2025 Priority Guidance Plan will identify guidance projects that the Treasury and IRS intend to actively work on as priorities during the period from July 1, 2024, through June 30, 2025.
Why the Need for the Requested Guidance?
A taxpayer patron’s gross interest expense paid to the credit cooperative is business interest expense subject to Section 163(j). The patron’s patronage dividend received from the cooperative is included in gross income under Section 1385(a)(1).
Under the final Section 163(j) regulations, the patron does not have a specific provision describing a procedure to net the patronage dividend with the business interest expense, even though under the facts of the cooperative lending arrangement the patronage dividend represents a rebate from the cooperative on the business interest expense paid by the patron.
Many farmers, fishermen, and rural agribusinesses operate at low profit margins and require recurring sources of borrowing to finance their operations, including planting, harvesting, and purchasing of farm and production equipment. These taxpayers chiefly rely on credit cooperatives for financing, and in many instances, these credit cooperatives are the only available source of financing.
In most instances, these loans are made on a patronage basis, meaning the borrower is a patron of the cooperative with an expectation that the patron will share in the cooperative’s annual patronage dividend distribution. The patronage dividend functions as an effective rebate on the business interest expense paid, thus reducing the patron’s cost of borrowing.
Next Steps with Summary Guidance Requested
Based on the conduit treatment for RICs provided in the Section 163(j) regulations and a similar legislative and judicial history of conduit treatment for patronage dividends of cooperatives, it’s appropriate for a patron of a credit cooperative to receive similar conduit treatment either as a Section 163(j) adjustment to treat the patronage dividend as business interest income, or under the historical price adjustment theory of patronage dividends, functioning as a rebate on the business interest expense paid, netting the patronage dividend with the patron’s business interest expense for purposes of Section 163(j).
This treatment is also analogous to Private Letter Ruling 201524017 from March 16, 2015, allowing netting of patronage dividends with interest expense for purposes of the REIT gross income qualification test under Sections 856(c)(2) and (c)(3).
The NCFC and NSAC comment letters request guidance to be issued by Treasury or IRS in the form of a notice, revenue ruling or amendment to the Section 163(j) regulations providing that a patron may net a patronage dividend received from a credit cooperative with the associated business interest expense paid to the credit cooperative for purposes of Section 163(j).
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For help understanding potential impacts of the requested guidance, please contact your Moss Adams professional.
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