How a Cooperative Business Works in the 21st Century

Learn about types of co-ops, advantages, problems, and taxation

Five young people outside at a table covered with fresh produce.
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 Mike Harrington/Getty Images

When you think of the word “co-operative,” you might think of a local food co-op, but there are many more types of cooperative businesses operating in the U.S. today. As some business owners and consumers look beyond traditional, capitalist ways of doing business, co-ops may provide one alternative. 

What is a Cooperative Business? 

A cooperative (co-op) is a business or organization owned by and operated for the benefit of its members. Profits or earnings are distributed among its members.The co-op can be a for-profit business or a non-profit organization.The co-op runs similarly to a corporation, because members purchase shares and elect a board of directors and officers. It differs from a corporation because typically each member gets one vote. Members of a co-op can be individuals, families, businesses, farmers/ranchers, or manufacturers. 

The International Co-operative Alliance and National Cooperative Business Association define a cooperative as a group of people with a specific need who work together to create a company to meet that need.

The cooperative movement dates back to the mid-19th century, but the concept goes back even further, to craft guilds, farmer organizations, and mutual insurance companies. The 21st-century cooperative movement has taken off with the growing emphasis on equality and concern about people and planet, in addition to profits (these three are sometimes called “the triple bottom line”).  

Types of Cooperative Businesses

These are some of the many types of co-ops, formal and informal, in operation today: 

  • Mutual insurance companies (most with the word “mutual” in their names) are owned by policyholders, rather than stockholders. 
  • Credit unions are not-for-profit organizations that serve their members. 
  • Rural electric power co-ops are private, not-for-profit organizations incorporated in 48 states to provide at-cost electric service to customers. 
  • Consumer-goods co-ops, like REI Co-op (yes, that’s part of its name). The company, an outdoor outfitter, says that “more than 70 percent of our annual profits are invested back into the outdoor community.” 
  • Producer co-ops, like Sunkist, owned by and operated for their member-growers. 
  • Cooperative buying clubs, in which a group of households gets together to buy foodstuffs in bulk and divide the orders among the members. 
  • Retail co-ops like Ace Hardware, which was formed in 1924. The company is still owned “solely and exclusively by the local Ace retail entrepreneurs.” 
  • Community-owned businesses, such as the Nebraska Cooperative Development Center, which has helped communities in small rural towns start cooperative grocery stores. 
  • Housing cooperatives are formed when people join to own or control housing and/or related community facilities. These co-ops are different from condo associations, in which each unit is privately owned and there is a common area owned jointly. 
  • Youth co-ops are businesses incorporated and run by young people to give them experience with one type of real-life work model. They can be set up in a school or community center or another organization that supports youth. 
  • Worker cooperatives are formed and owned by employee groups that generate profits for the company and its workers.

Pros and Cons of Co-ops

As demonstrated by the descriptions of several types of cooperative businesses above, organizing a group with a common business purpose in this way can pay off. Positives and negatives can include:

Pros
  • Lower costs by buying in bulk

  • Common protection from loss (mutual insurance companies)


  • More price power for sellers when joining together (like Sunkist)


  • Equal say in the business for members


  • Shared values. Many co-ops (like REI) value more than just making a profit


  • Tax advantages for co-ops organized as non-profit businesses


Cons
  • Less opportunity for outside investors because they can’t gain control

  • Lack of interest by members over time

How to Start a Cooperative Business

A co-op can be as simple or complex as you want. You can decide to start a co-op like a food buying club just by getting together with other families to order and distribute food. As you grow beyond this small group, you should form a cooperative business in your state. 

Step 1

Business Type. You’ll need to decide on a business type (corporation, partnership, or LLC) and register your business with a state.  

Some states have regulations specifically for cooperatives (New Mexico, for example.) In some states, you must be formed under co-op status to use the word “cooperative” in your name. 

Step 2

You’ll need to do all the other tasks involved in forming a corporation, partnership,  or LLC, including electing a board of directors to oversee the operations. 

Step 3

If you want to be non-profit (exempt from income tax), you first form the business, then apply for tax-exempt status. See IRS Publication 557, “Tax-Exempt Status for Your Organization,” for details. 

Cooperative Businesses and Taxes

The overall philosophy of cooperatives is that they are intended to operate at cost, so there’s no “profit,” and the patrons (those doing business with the co-op) receive net earnings on an equitable basis. 

The IRS allows several different federal income tax options for cooperative businesses. One variation is exempt from tax and another is subject to tax. 

The federal tax agency considers cooperatives exempt from federal income taxes if they meet certain qualifications. To qualify for and maintain exemption (Internal Revenue Code 501(c)(12)), the cooperative must:

  1. Be organized and operated as a cooperative
  2. Conduct business as set by the tax code and IRS regulations

It must receive 85% or more of its income each year from its members and use the income solely to meet the cooperatives’ losses and expenses. 

Taxes for cooperative businesses are complicated and getting non-profit status from the IRS is not for amateurs. Get help from a tax attorney if you want to form a cooperative business. 

A Subchapter T cooperative is subject to tax. This co-op type may conduct any kind of business. Members or patrons (those doing business with the co-op) can be individuals or organizations. The co-op returns margins (net earnings) each year to users as patronage refunds, based on the amount of business each user does with the co-op. The tax is paid by the cooperative on a temporary basis; it receives a deduction when the money is passed on to the patrons.  

For More Information in Your State

The National Agricultural Law Center has a state-by-state list of Business Organization Forms and Filing Instructions that could be helpful. Also, the National Cooperative Business Association has a spreadsheet (Excel download) showing the cooperative business regulations in each state.  

Article Sources

  1. Small Business Administration. "Choose a Business Structure." Accessed March 24, 2020.

  2. Cornell Legal Information Institute. "Cooperative." Accessed March 24, 2020.

  3. Cooperative Directory Service. "Coop Directory Service." Accessed March 24, 2020.

  4. U.S. Department of Agriculture. "Income Tax Treatment of Cooperatives." Page 2. Accessed March 24, 2020.

  5. IRS. "General Survey of IRS 501(c)(12 Cooperatives and Examination of Current Issues." Page 177. Accessed March 24, 2020.