Basics of Forming and Maintaining Cooperatives in Maryland
A cooperative is a business or nonprofit organization owned and operated by the people who either use or provide its services. The people who own the cooperative are called “members.” Members can be the workers, producers, or consumers of the cooperative. Cooperatives exist in nearly every sector of the economy and employ millions of people each year. Common examples of cooperatives include credit unions, taxis, childcare, housecleaning, rural electric, health care, insurance, and farming.
Cooperatives generally share the following principles:
- Democratic Governance - Cooperatives generally have a one member, one vote rule. This is different from traditional business models, which often weight each owner’s vote by the amount of that person’s stake in the business. However, some cooperatives have an elected board of directors to oversee the day-to-day operations of the business, leaving strategic decisions to members as a whole.
- Consensus Building – While each member has one vote, cooperatives encourage members to work with one another in their decision-making progress. If members want the cooperative to take a certain action, they must collaborate and gather most, if not, all members to agree.
- Community-Centric – Most cooperatives have members from the same area. Because members live where they work, they are more likely to invest there. As cooperatives become a significant part of a community, they have less incentive to leave.
- Member Satisfaction Superior to Capital – Cooperatives must earn a profit in order to survive as a business. However, a member's well-being is valued above earning more money. Many cooperatives have rules that keep the workplace fair, and preserve the workers’ due process rights and safety.
- Self-Determination - Members are more likely to invest their time and energy in the cooperative because they have input in its decisions and would share any wealth that comes from it. While traditional business models limit decision-making to its senior leadership, cooperatives give each member a stake in its future.
- Training – Cooperatives usually have an apprenticeship program or other training that prepares new members to participate in the business. For cooperatives to survive, they must recruit, train, and continuously develop their members.
- Open Membership – Cooperatives generally allow any person to join regardless of gender, race, religion, political, or social status. To become a member, many cooperatives require an entry-level training program, an initial capital investment, and final approval by the membership.
ISSUES TO CONSIDER WHEN FORMING A COOPERATIVE
Any group interested in forming a cooperative must first make a series of important organizational decisions. The first is to determine under which legal structure the group will formalize and register with the government (i.e. organize or incorporate).
In Maryland, cooperatives may take several different forms. For instance, a cooperative may choose to incorporate under the Maryland Consumer Cooperative Act. A cooperative may formalize as a Maryland cooperative under the Maryland Consumer Cooperative Act if it plans to “engage in any lawful business to acquire, produce, manufacture, furnish, or distribute goods or services.” Maryland cooperatives may also choose to organize themselves as a Limited Liability Company (“LLC”) under the Maryland Limited Liability Act. Finally, a cooperative may incorporate as a standard Corporation. Factors to keep in mind when choosing a structure include: the purpose of the cooperative, the number of members, the need for flexibility in adding and removing members, and taxation. It may be best for the group to consult an attorney to assist in the decision making process.
Read the Law: Md. Code Ann., Corps. & Assns. § 5-5a-03
Regardless of which legal structure the group chooses to organize or incorporate under, the group must adhere to the basic principles of cooperatives to be considered a cooperative. Therefore, the next organizational decision the group faces is how it will manage the newly formed cooperative. The most basic principle of cooperatives requires that the entity be member managed with each member having one vote. This can be accomplished through a direct democratic process in which members vote regarding each organizational decision and the majority vote wins. Factors to consider with this option include: how often will members need to meet to vote on decisions, how many members must be present for a vote to take place, and what constitutes a majority.
Members may also manage the organization through a republican structure. This occurs when each member votes for a subgroup of members to serve as representatives. The representatives are then responsible for making decisions for the organization as a whole. A mix of both methods may also be used, allowing representatives to handle day-to-day managerial duties while requiring a direct democratic vote by all members for important organizational decisions.
After determining how the cooperative will be managed for the mutual benefit of all the members, the group should consider how it will add and remove members in the future. Many cooperatives require new members to “buy in,” making a monetary contribution to the cooperative prior to joining. The group should consider whether this membership fee will be returned if the member decides to later leave the cooperative.
Worker cooperatives may require that a prospective member work for the cooperative as an employee prior to joining the cooperative to ensure the prospective member will be a good fit. Worker cooperatives may also require a “buy in” before allowing a new member to join. Again, the cooperative should decide whether this fee will be returned if the member leaves. In addition, the cooperative should have a process in place that will allow it to remove (terminate) a member from the cooperative.
COMMON TYPES OF COOPERATIVES
There are many types of cooperatives. These include producer cooperatives, multi-stakeholder cooperatives, purchasing cooperatives, utility cooperatives, consumer cooperatives and worker cooperatives.
This article focuses on two of the most common types of cooperatives: consumer cooperatives and worker cooperatives.
Consumer cooperatives are enterprises that are owned by consumers who want to achieve better prices or quality in the goods or services they purchase. Consumer cooperatives are typically democratically managed. Therefore, each member/consumer of the cooperative is allocated one vote.
As an example of how a consumer cooperative operates, picture a group of friends who enjoy eating cookies. They could create a consumer cooperative to purchase cookies collectively and obtain bulk discounts on cookies they purchase. Each member’s investment is measured by how many goods and services each buys from the cooperative.
Consumer cooperatives are located all over the world. Some of the most well-known consumer cooperatives include: REI, the largest American consumer cooperative specializing in outdoor sporting equipment; Co-op Kobe, the largest consumer cooperative in Japan with over 1.2 million members; and PCC, the largest consumer-owned food cooperative.
An example of a Maryland consumer cooperative is the Greenbelt CO-OP Supermarket and Pharmacy. Membership in this consumer cooperative provides shoppers the chance to share in the cooperative’s patronage refunds. A patronage refund is distributed to cooperative members when the business has a surplus (or profit) at the end of the year. It is usually distributed to the members based in direct proportion to a cooperative member’s patronage (or purchases) and is usually made up of patronage equity and store credit. More information about how Greenbelt CO-OP’s membership benefits and patronage refunds work is available on their webpage, at http://www.greenbelt.coop/cms/index.php/join/member-benefit/.
Worker-owned cooperatives are enterprises owned by the persons who perform the labor for the organization. Individual worker ownership is a key element of the worker cooperative. The cooperative’s members are generally very involved throughout the day-to-day operations of the business. Although worker cooperatives are popular worldwide, they are just catching on in the United States.
Each member’s investment in the worker cooperative is measured by how much time he/she spends working for the cooperative or by the value of the work he/she contributes to the cooperative.
Almost any business can be organized as a worker cooperative. Examples include restaurants, bakeries and retail stores. Some well-known worker cooperatives are Equal Exchange headquartered in Massachusetts, a fair trade importer of chocolate and coffee and MONDRAGON Corporation located in Spain, one of the world’s largest worker cooperatives that employs over 80,000 workers. More information about Equal Exchange is available at http://www.equalexchange.coop. More information about MONDRAGON Corporation is available at http://www.mondragon-corporation.com/eng/.
An example of a Maryland worker-owned cooperative is Glut Food Co-op. Glut is a worker-managed cooperative located in Mt. Rainier, Maryland that sells whole foods and other grocery store products. More information about Glut Food is available at https://glut.org/.
TAXING A COOPERATIVE
One of the unique aspects of being a cooperative is receipt of “pass through taxation” benefits from the IRS. Typically, a corporation is taxed twice at the Federal level: once on its profits, and again when surplus is paid to shareholders. With pass through taxation, profits are only taxed when they are distributed to the shareholders/owners.
For cooperatives, distributions to owners are generally known as “patronage.” Patronage distributions are typically made when the cooperative’s board of directors, governing body, or membership determines that the cooperative has enough profits for the year to give excess to its owners. Cooperatives benefit from the IRS’s method of taxing the cooperative’s patronage.
The IRS provides special rules for taxing cooperatives under Subchapter T of the Internal Revenue Code. Under Subchapter T, a cooperative business is not taxed on income given to its owners through a patronage. A cooperative receives this special treatment so long as it has a method for paying patronage, even if patronage is not actually paid in a given year.
For example, suppose that a cooperative’s bylaws state that it will pay a patronage in any year where it has $100,000 in profits. Even if the cooperative does not make much profit for the first years of its operation, it is still taxed under Subchapter T. If the cooperative clearly and fairly outlines the patronage process in the bylaws, and then follows these bylaws and other requirements for cooperatives outlined in Subchapter T, it will receive pass-through taxation for all income that is given to its owners.
Finally, the refund must be based on the amount of business the recipient did with the cooperative. Frequently, this means that a cooperative’s patronage to an owner is based on how many hours she worked or how much she purchased from the cooperative. For example, if Mary purchases $1,000 worth of goods from the cooperative, and Bob purchases $500 worth of goods from the cooperative, Mary should receive a larger patronage.
The rules above apply to taxation from the Federal Government. In Maryland, a business entity is taxed as either a pass-through entity or a corporation. Therefore, any potential Maryland cooperative should seek the aid of a tax professional to determine their proper tax structure.
For those interested in learning more about the taxation of a cooperative, please refer to more detailed resources, including Subchapter T of the Internal Revenue Code, or an accountant familiar with cooperative businesses. Read the Law: 26 USC Chapter 1, Subchapter T - Cooperatives and Their Patrons