by Attorney Deborah Groban Olson
Executive Director, Center for Community Based Enterprise
Workshop at US Federation of Worker Co-ops
Annual Conference, Chicago, IL June 1, 2014
What is a Worker Co-op?
• for-profit business
• jointly owned and democratically controlled
• by its worker owners
• limited return on equity investment
• operated on the Int’l Co-op Alliance Principles
(1996) originating from the Rochdale Principles
Principles are the defining core of a worker co-op
Many different legal structures are used due to
business needs and state laws
International Co-op Alliance
1. Voluntary and Open membership.
2. Democratic member control.
3. Member Contribution to Capital.
4. Autonomy and independence.
5. Education of members and public in cooperative
6. Cooperation between cooperatives.
7. Concern for community.
Common Features of Worker
•Usually include all full-time workers & majority ownership
•One vote per person
•Surplus returned on the basis of patronage not equity
•Member supermajority vote on selling to outsider
•Some tax benefits
•Capital financing can be difficult
•Michigan securities exemption for non-profit co-ops
Issues to Consider
• Liability Protection
• Need for outside investment
• Incentive for selling owner if conversion
• Tax treatment
• Ease of operation/accounting
• Settled law
• Employee vs. Owner
• Using the word “cooperative”
Worker Co-op Structure Options
• Cooperative under state law
• Corporation (S or C)
• Non-profit tax exempt corporation
• ESOP organized on co-op principles
• Additional status options:
• Eligible Worker Owned Co-op – IRC §1042(b)
• B Corp status – B Lab or state law
State Worker Co-op Laws
• Many states limit use of the word “cooperative” or
“co-op” in company name to those incorporated under a state
• Some states have worker co-op laws
• Mass, CA, PA (See State Worker Co-op Laws as of 2012 www.c2be.org/resources)
• Some, like Wisconsin, have a well developed general co-op law
that can be used for worker co-ops
• In some states you might use the agricultural co-op or consumer
• Some have no co-op laws – or you may choose to create co-op
features within a C or S corporation, an LLC or L3C
• Legal definition of “organized on a co-op basis” is case law
New Generation or LLC/Co-op
Wisconsin’s Chapter 193, “co-op LLC law” authorizes the creation of membership
interests for investors who are not patrons of the cooperative.
• Investor members’ voting rights may not exceed a total of 49% but the
bylaws may provide investor members with the power to veto certain
unusual decisions such as merger or dissolution
• Investors’ may not receive more than 70 percent of the profit allocations and
distributions of the cooperative.
• A Chapter 193 co-op may elect to be taxed as a partnership under Subchapter
K of the Internal Revenue Code, or as a cooperative under Subchapter T
However, some experienced Wisconsin Co-op attorneys prefer to use the well
structured traditional co-op law, Chapter 185, that also allows for different classes
of members, called “divisions” with different rights
Eligible Worker Owned Co-op
An EWOC is special type of co-op (IRC §1042) that permits selling owners to
defer payment of capital gains tax on the proceeds of the stock they sell to a
worker co-op, if the proceeds are reinvested in domestic stock. If the reinvestment
stock is in the owners’ estate upon death, the family never pays the capital gains
To qualify as an EWOC, a worker co-op must have these features:
• A majority of the co-op’s members must be company employees;
• A majority of the co-op’s voting stock must be owned by co-op members;
• A majority of the board of directors must be elected by the members on a 1
vote per person basis, and
• A majority of earnings and losses are allocated to members on the basis of
their work, their capital contributions or a combination of both.
Worker Co-op Accounting & Tax
Tax advantages of co-ops under Subchapter T of the IRC
• Surplus attributable to member-labor is not subject to the corporate
• Surplus allocated to members on the basis of their patronage is
taxable to the members but not to the co-op.
• Some co-ops generate revenue from both members and non-
To qualify for taxation under Subchapter T:
• Benefits of operation to members
• Democratic control by members – one member one vote
• Earnings returned in proportion to patronage
Sub Chapter T Tax Benefit
Co-op A has 15 members and 3 non-member employees (in
their probation period - not yet been admitted as members)
Co-op must determine how much of its surplus was generated
from the work of the
• members versus the non-members.
• Only the portion generated from the members is exempt
from the corporate double tax.
Worker Co-op Member &
Collective Capital Accounts
• When members join a co-op, they make an initial capital contribution. This is the starting
balance in the member's capital account. The capital account is not a separate bank
account but is accounted for on the books of the co-op and is basically the property of
the member, though the funds are kept in the co-op's account.
• The co-op has rules about how and when the members can get the contents of their
capital account back out of the co-op. Usually, a member does not get his/her capital
back until he/she leaves the co-op. Often when he/she leaves the co-op, the balance in
the capital account converts to a loan from the departing member to the co-op and the
co-op pays it back over time.
• At the end of each year, the co-op determines whether its revenue exceeded expenses.
If there was a surplus of revenue over expenses, the co-op may decide to retain a
portion of the surplus in a “collective account” as a reserve.
• The collective account is separate from the member capital accounts (compare to
LLCs and S Corp where this cannot happen). The co-op may pay tax on earnings not
allocated to members.
• After setting aside a reserve in the collective account, if there is still additional surplus,
the co-op will pay patronage dividends to its members.
• Patronage is usually calculated based on hours worked.
Patronage Dividends & Capital
• The co-op can choose to pay the entire patronage dividend in cash, or it may pay a
portion in the form of a Written Notice of Allocation (WNA).
• Use of WNAs allows the co-op to retain more cash within the co-op. Unlike the
surplus allocated to the collective account, WNAs are allocated to the member
capital accounts and become the property of the members.
• Co-op sets policy as to when members may withdraw these funds as cash from
their accounts. WNAs are usually redeemed on a rolling basis.
• Some co-ops pay interest on the balance in the member capital account.
• The members pay income tax on the ENTIRE patronage dividend, regardless of
whether it was received in cash or in the form of a WNA.
• If members receive less than 20% of the patronage dividend in cash, the WNA is
nonqualified and the co-op may not benefit from the Subchapter T exemption from
double tax. The member does not pay tax on a nonqualified WNA until he/she
receives it in cash.
• Losses may also be allocated to member capital accounts as determined by the co-
• Some states (MI) provide special securities exemptions for sale
of co-op memberships
• In non-profit co-op
• Thus best to create worker co-op under consumer co-op law
• Using LLC law requires more detailed disclosure
• Federal law holds that sale of co-op membership is not sale of a
• Securities laws regulate the sale of business interests to
particularly to “unsophisticated investors”
• Automatically created when a group of people get together to
run a business – no filing required
• No liability protection for partners – each partner is
personally liable for any liabilities or debts of the partnership
• Pass through entity for tax purposes
• Partners are not employees
• Some states have limited liability partnership laws, but in most
cases these are now structured as LLCs
• Traditional business corporation, taxable at company and shareholder levels
• Shareholder primacy (vs. stakeholder statutes)
• Liability protection for owners (shareholders)
• Owners that work in the company are employees
• No self employment tax
• Employment law applies
• Likely traditional preferred stock or bonds used when outside investors are
• Dividends must be in proportion to stock ownership
• Biggest complaint about corporations: double tax
• S election – taxed like a partnership
• Special tax treatment for co-ops – SubChapter T & some state laws
• ESOP portion of S corporation – pays no federal income tax
• No tax at corporate level – tax liability passes thru to members, except ESOP
• Phantom income problem
• Unlike C Corp can’t have multiple classes of stock
• Special requirements to maintain S Corp status:
• No more than 100 shareholders
• Shareholders must be individuals; citizens, legal residents, ESOP or
• Only one class of stock (different voting rights not considered a different
• Failure to meet these requirements results in automatic loss of S status
• Owners are employees – no self employment tax
• Tax on ESOP allocations to members is paid upon retirement or termination
Employee Stock Ownership Plan
ESOP (Employee Stock Ownership Plan) is:
• an employee benefit plan and trust
• Invested primarily in employer stock
• highly tax-favored
• employees share ownership in their company as trust beneficiaries
• allocates shares to each eligible employee every year
• gives employees increasing ownership stake as they accumulate
• distributes these shares to employees, usually sometime, after
they leave the company, to fund their retirement.
ESOPs – pro & con
• Ownership can transition to employees over time
• Can own any % of Company
• Easier to finance
• Can have 1 vote per person & allocations based on hours worked
• Many tax benefits to seller, company & employees for C & S corporations
• Contributions of stock are tax deductible to company
• Contributions to pay for stock purchase principal and interest are deductible
• Stock dividend distributions can be deductible
• Capital gains deferral for seller
• ERISA Plan - Employees vote stock through a trust
• Allocations usually based on pay
• May have substantial or limited EO voting & voice
• Trustee is actual owner/ employee is plan beneficiary
• Trustee decides about sale to outsider
• Trustee’s obligation is to workers as retirees
• Annual valuation and legal expenses
Example of Co-op style ESOP
•Started in 1851
•Part of PPG
owned USW co-
op style ESOP
MBC ESOP with co-op values
Sees itself as long term community asset
Must retain competitive edge to continue
Maintains cash reserves
Reinvests in company
Balances risk- protecting investment of older
workers & jobs needs of younger worker
Involve workers in all major decisions
Maryland Brush: co-op governance
structure in a 100% S corporation ESOP
4 internal board members
Local union president
1 selected by salary group
1 selected by wage group
3 external board members
1 appointed by USW district director
1 appointed by MBC president
1 nominated by USW, affirmed by MBC
Mature markets problem – Maryland
Brush finds solar product
Specializes in custom designed power brushes for:
Nonferrous metals industry
Truck Tire retread industry
Industrial distributor market
Special machinery market
By 2007 - Maryland Brush Company knew it needed to
diversify outside of the brush industry
Found new solar energy product
2010 MBC bought Photensity with
S Corp ESOP savings
Now called “Skylouver”
LLCs & L3Cs
LLCs - limited liability same as corporation
• taxed like partnerships
• can elect to be taxed as corporations
• owners (members) are not employees
• member managed vs. manager managed
• all earnings subject to self employment tax (guaranteed payments
• phantom income problem
• cannot have unallocated equity – all equity is allocated to member
• very flexible & easy to form
• co-op features created in operating agreement
Low Profit LLC = LC3
L3Cs are LLCs:
• For profit but with a primary social purpose
• designed to attract foundation investments & some market rate
investments to serve social purpose
• can only be formed in a few states (MI is one)
• Can provide stakeholder instead of shareholder primacy
• similar purpose as B corp in states without formal B corp
Example: Ingenuity US, L3C
Ingenuity US, L3C (IUS) is
• a Detroit based, community innovation broker and business developer
• focused on building patient, community-focused capital and cooperative business
• providing a supportive ecosystem for sustainable, locally rooted and employee
• that provide jobs with limited barriers to entry for Detroiters with limited formal
education where employees build skills and leadership on the job.
• the for-profit arm of the Community Economy Group which includes the non-
profit Center for Community Based Enterprise (C2BE)
• adapting proven models of cooperative economic and social practices, to help
accelerate Detroit’s transformation to a sustainable and inclusive local economy.
• C2BE created the Detroit Community Cooperative (DCC) - a network connecting
a wide-variety of like-minded Detroit businesses.
IngenuityUS, L3C Mission
Ingenuity US is building a co-operative of business, non-
profits and individuals founded on our values, enabling a
vibrant, rooted, growing, sustainable community in
Möbel Link Furniture, an
• Every person desires and deserves dignity.
• Children are raised and educated by communities.
• Meaningful work, at living wages, is the foundation of dignity.
• Meaningful work includes participation in making decisions that affect ones’ work.
• Making good decisions about work requires acquiring necessary knowledge and skills.
• Workers and managers are equally responsible for creating an educated workforce.
• Self-respect and respect for others is the basis of community.
• People build community by working together for common aims, playing together, eating together and
taking care of each other.
• Globalization of the economy is destroying much of the basis of community.
• All the skills and resources necessary to build a vibrant, sustainable community are available in
Detroit and SE Michigan.
• Embracing change, and high quality, continuous education are necessary for building and sustaining
an enterprise based community.
• Employee and community-based ownership provide long-term stability to enterprise-based
• Creation and maintenance of such a community welcomes partnerships with privately owned
businesses that respect our values.
• Our products will be earth and community friendly.
Self Employment Tax on Worker
Co-op Patronage Dividends
“Over the past few years, IRS Examination (audit function) undertook correspondence “audits” of
several members of worker cooperatives asserting the position that the member’s patronage
dividends are subject to self-employment (SE) tax. Attorney Greg Wilson fought these cases
asserting that patronage dividends were not subject to SE tax for various reasons. Eventually, an
attorney for the IRS – IRS Counsel’s Office – in San Francisco, asked the IRS National Office for
guidance on this issue. It appears that the IRS National Office concluded that patronage dividends
paid by worker cooperatives are indeed not subject to SE tax and dropped the cases where it was
asserting SE tax applied to worker coop patronage. But the IRS arrived at this conclusion because
they determined the worker/members are employees of the cooperative and employees
generally cannot receive both employment and self-employment compensation from the same
entity. Continuing with this theme, the IRS then hinted that its position might be that patronage
dividends paid by worker coops should be subject to employment taxes at the cooperative level –
instead of SE tax – like a bonus paid to an employee. Where the IRS is going with this now is
unclear. “ 2009 Atty. Jenny Kassen
Tax Exempt Non-Profit 501c3
Incubated Co-ops, such as Evergreen, often have a central non-
profit entity that has foundation or other investors who want to
• invest in a non-profit
• with a board that includes parties other than the workers
• or begins with no worker members
• protect their social capital from being distributed to
individual members upon demutualization of the co-op
• May serve as launching pad for for-profit incubated worker
co-ops after training, etc.
Benefit “B” Corporation• Is a status that can be held by a non-corporation
• Generally is not based on state statute, except in Hawaii & a few states that have “B” Corp
• B Lab has created a set of standards for certifying “B” corporations
• Many states, like Ohio, have “constituency” statutes that permit the corporate charter to have
language that allows the board to consider interests of stakeholders other than solely the
To become a B Corp in a “constituency” statute the corporate charter must require the board of
directors to consider “such factors as the Director deems relevant, including, but not
limited to, the long-term prospects and interests of the Company and its shareholders, and the social,
economic, legal, or other effects of any action on the current and retired employees, the suppliers
and customers of the Company or its subsidiaries, and the communities and society in which the
Company or its subsidiaries operate, (collectively, with the shareholders, the “Stakeholders”),
together with the short-term, as well as long-term, interests of its shareholders and the effect of the
Company’s operations (and its subsidiaries’ operations) on the environment and the economy of the
state, the region and the nation.”
•US Federation of Worker Co-ops
• Center for Community Based Enterprise,
www.c2be.org/StateWorker Co-op Laws as of 2012
• Arizmendi Association of Cooperatives
•National Cooperative Business Association
•International Cooperative Alliance
•University of Wisconsin Cooperative Extension
•Circle Pines Center
For more information contact