Market Governance

This month’s posting is in response to two comments on the March posting about income taxes and not-for-profit agricultural cooperatives, an organizational model that is used by some farmers’ markets. Income tax and tax exempt status are complicated, but saying that doesn’t help much. I’m not a tax expert, but I can give some basic information.

First, AFMC and, apparently, SFMA are incorporated in New York State as not-for-profit agricultural cooperatives. Members own the organization and elect a number of the members to guide the organization on behalf of the members. As agricultural cooperatives, each organization pays a $10 corporate tax to New York State each year. This incorporation has nothing to do with federal income tax.

When it comes to income tax, it’s a totally different situation. In the United States Tax Code, tax exemption from income tax is in Section 501 (c) 3. This section establishes three and only three classifications for an entity to be exempt from income tax. They are religious work, charitable work, and education. Farmers’ Markets do not qualify under any of the three. So farmers’ markets can be organized as not-for-profits in New York State, but federally they are considered regular corporations like IBM and ExxonMobil. It doesn’t seem fair, but until the tax code is revised, we have to live with it.

There are two ways agricultural cooperatives can manage the income tax situation. One is through a return of income to the members that is over the amount needed to pay the cooperative’s expenses. It is similar to a for-profit corporation’s dividends. Then the cooperative members pay income tax on their share of the return of equity. As to how to make the return, I suggest looking at a copy of the incorporation papers that were filed with the State of New York when the cooperative was formed. Generally a method of returning funds to members has to be listed in the incorporation filing.

If your group is looking to become an agricultural cooperative, contact the New York Department of State for guidance in completing the process. Forms for filing are probably available on the State’s website. I would highly recommend working with a tax attorney to make certain it is done properly. You may be able to find one who will help you pro bono or give you a break on the fee.

The other way is to manage the cooperative’s income and expenses so they balance at the end of the year. It is hard to do, but it starts with careful financial planning before the beginning of the financial year. Reviewing the end-of-the-year financial statements for two or three years can give you a good idea of the costs of managing the cooperative for a year. Using those statements and some good faith estimates (basically guesses) on what the year will be like, the Treasurer working with a finance committee can develop a projected budget with income and expenses that are equal for the year.

For the good faith estimates include the health of the economy in the area, expected vendor participation, market promotion, gas prices, demographics of the area (age of the population, income levels, family size), and esoteric things such as the local food movement.

Next comes the hard work of sticking to the budget. During the year the Treasurer and the Board need to monitor the income and the expenses monthly to see that they stay in balance. If income starts to exceed expenses, then the Treasurer needs to recommend areas where expenses should be increased. Adding advertising, buying new signs and banners, prepaying some expenses for next year, creating “good customer” incentives, or buying picnic tables so customers can lunch at the market are ways of using up income to keep it in balance with the expenses. This is the method AFMC uses.

Even with increasing spending, the budget doesn’t always balance at the end of the year. However, it can get you close enough that the income tax incurred is minimal. It may also indicate that you need to reduce income for the following year by cutting vendor fees. This always makes vendors happy!

I would make one further comment on income taxes. It is nice to have a small cushion to rely on in tough budget years. So it doesn’t hurt to occasionally pay a small amount of income tax if it allows you to retain some earnings. The earnings can be invested in a savings account or Certificate of Deposit and be available for a year when expenses exceed income.