Socialism: fit profit sharing to co-op tax law so members are taxed once

Co-Authored-By: Claude Opus 5.5 <[email protected]> Claude-Session: https://claude.ai/code/session_01QWPs69B8nQZjtPEUXMKzZx
2026-09-24 21:44:16 -06:00
parent a9efaa2725
commit 1e82052324
10 changed files with 149 additions and 12 deletions
@@ -29,19 +29,19 @@ When the co-op makes a profit, it gets split. These are the defaults. Each co-op
 | --- | --- | --- |
 | **At least 30%** | The co-op's permanent reserve | Nobody can ever withdraw it (see [indivisible reserves](the-lock.md)). It's the firm's cushion and its own source of investment money. |
 | **Up to 10%** | The federation's shared fund, if the co-op belongs to one | Pools risk between co-ops (see [The Federation](federation.md)). |
-| **The rest, about 60%** | Members, divided by each member's share weight | This is the "profit share" from [Worker Ownership](worker-ownership.md). It ramps up with tenure, then caps. |
+| **The rest, about 60%** | Everyone who worked that year, divided by hours worked | This is the "profit share" from [Worker Ownership](worker-ownership.md). It ramps up with tenure, then caps. The part of a share someone hasn't reached yet goes to the reserve ([How a Locked Co-op Is Taxed](taxes.md)). |

 Mondragon's original split was similar: 10% to education and the community, at least 20% to reserves, and up to 70% to members. It later raised the reserve minimum to 50% (Morris, 1992).

 The members' share is then split again, between cash now and the account:

 - **At least 20% of it is paid in cash right away.** Members owe income tax on their whole allocation in the year it's made, including the part that goes into the account. The cash is there so they can pay that tax. This is how US co-op tax law works ([Democracy at Work Institute guide](https://institute.coop/sites/default/files/resources/Internal-Capital-Accounts.pdf)). The default is half in cash.
- **Lower-income members can take it all in cash.** For a low-wage worker, being taxed on money they can't touch can cost them tax credits and health-care subsidies. So any member whose household income is under twice the poverty line can take their whole share in cash.
+- **Lower-income members can take it all in cash.** For a low-wage worker, being taxed on money they can't touch can cost them tax credits and health-care subsidies. So any member whose household income is under twice the poverty line can take their whole share in cash. If they leave some in their account, by default they aren't taxed on it until it's paid out ([How a Locked Co-op Is Taxed](taxes.md#capital-accounts)).
 - **The rest goes into each member's account.**

 Members can also raise their own salaries instead of taking profit, but that doesn't get around the reserve. It takes its share of pay above the going rate too (see [Investing for the Long Run](the-long-run.md#the-rules)).

-**A worked example.** A 40-person co-op makes $600,000 in profit after paying everyone's salaries. It puts $180,000 in its permanent reserve and $60,000 in the federation fund. The remaining $360,000 is divided among members by share weight. Say the members' share weights add up to 36. A member at full share then gets $10,000: $5,000 as a check and $5,000 added to their account.
+**A worked example.** A 40-person co-op makes $600,000 in profit after paying everyone's salaries. It puts $180,000 in its permanent reserve and $60,000 in the federation fund. The remaining $360,000 is divided by hours worked. If all 40 members work the same hours, each one's hours earn $9,000. A member at full share gets it all: $4,500 as a check and $4,500 added to their account. A member at half a share gets $4,500, and the other $4,500 goes to the reserve. Profit earned by the hours of workers who aren't members yet is shared the same way, paid in cash, at the share of a member just starting out. Federal tax law is why it works this way ([How a Locked Co-op Is Taxed](taxes.md)).

 ## How the account grows

@@ -42,7 +42,7 @@ The standard bylaws share results with every member every quarter, or every mont

 ## Team bonuses the members design

-The profit share is split equally, and that doesn't change. But pay can include bonuses ([Who Sets the Pay](pay.md)), and a co-op can pay team bonuses tied to results the team can see and affect. The study found that the bigger the gain-sharing bonus, the more workers acted against shirking.
+The profit share is split equally per hour worked, and that doesn't change. But pay can include bonuses ([Who Sets the Pay](pay.md)), and a co-op can pay team bonuses tied to results the team can see and affect. The study found that the bigger the gain-sharing bonus, the more workers acted against shirking.

 The required rules keep bonuses from becoming a way to reward friends or push people too hard:

@@ -79,7 +79,7 @@ Co-ops that hire managers can let them dismiss members directly. The member can
 - **No retaliation.** If a member is dismissed within 12 months of organizing, filing a complaint, reporting a safety problem, running for the board or leading opposition in a vote, the co-op has to prove the dismissal had nothing to do with it.
 - **Quitting under pressure counts.** A member who quits within 60 days after a transfer, a cut in hours or pay, or being left out of a bonus can ask for a hearing, and the quit is treated as a dismissal. That's the same test [When People Don't Stay Long](high-turnover.md#no-pushing-people-out-before-theyd-join) uses for workers on probation.
 - **Probation isn't a loophole.** Workers on probation get a shorter version of the same hearing. Dismissing them for performance still counts in the test against pushing people out before they'd join. Only the narrow reasons listed there, like a client's safety, are excluded.
- **The savings are safe.** A dismissed member's [capital account](capital-accounts.md) is fixed on the day they leave, they get a share of that year's profit for the months they worked, and it's paid on the normal schedule. Nothing can be taken out of it without a court or arbitrator's ruling.
+- **The savings are safe.** A dismissed member's [capital account](capital-accounts.md) is fixed on the day they leave, they get a share of that year's profit for the hours they worked, and it's paid on the normal schedule. Nothing can be taken out of it without a court or arbitrator's ruling.

 **Published.** Every year the co-op reports warnings, hearings and dismissals by gender, race, age and disability, along with the results of an anonymous survey on workload and bullying.

@@ -30,6 +30,8 @@ For the members, it depends on the ramp. New members start at a fifth of a full

 (The 10-year ramp here starts at a tenth of a share and adds a tenth each year.)

+**Tax law changes this table.** It assumes the part of a share new members haven't reached yet goes to the other members. Under the model's default tax rules, it goes to the co-op's reserve instead ([How a Locked Co-op Is Taxed](taxes.md#the-tenure-ramp)). Then each full share drops to about $16,700 from the first year, and in year 1 the reserve gets about $267,000 extra with the five-year ramp. The table holds only for a co-op that pays the difference as wages for years of service, at the cost of payroll tax. Either way, that makes the spin-off route below more important.
+
 A member near retirement comes out ahead either way. A member with twenty years ahead loses about $50,000 over that time with a five-year ramp, and about $35,000 with a ten-year one. Counting money later as worth less than money now (at 7% a year), those losses are about $23,000 and $10,000. The gains come first and the losses later, so members who expect to leave soon and members who expect to stay long will vote differently. The ramp softens the problem. It doesn't remove it. In the end, **the new line has to earn the co-op's average, not just a profit, before the members come out even.**

 **Where it bites, and where it doesn't.** The gap only matters when profit per member is high. In home care, a full share is worth a couple of thousand dollars a year ([When People Don't Stay Long](high-turnover.md#the-ramp-when-people-leave-early)), so a new line that earns less costs each member a few hundred dollars at most. In a firm making tens of thousands of dollars per worker, the kind described in [What If Conservice Had Been a Co-op?](conservice.md), it's real money. And the most profitable co-ops are the ones whose growth matters most.
@@ -61,7 +61,7 @@ So in this model, **the buy-in comes out of the member's own profit shares, not

 Probation still can't be longer than 12 months. But a co-op can make it shorter, and the model's standard bylaws use three months, as Cooperative Home Care Associates does. The table shows why a high-turnover co-op will want that: at 38% turnover, a three-month probation puts about 91% of the workforce past it.

-**Why letting people in early is affordable.** It's the [profit share ramp](worker-ownership.md). A new member starts with a small slice of the profit that grows over the years. So admitting someone after three months costs the other members very little money. What the new member gets right away is the vote. Under this model, that doesn't wait.
+**Why letting people in early is affordable.** It's the [profit share ramp](worker-ownership.md). A new member starts with a small slice of the profit that grows over the years. So a new member takes only a small slice of the profit at first. The rest of what their hours earn goes to the co-op's reserve, not to the other members, because of how federal tax law treats profit shares ([How a Locked Co-op Is Taxed](taxes.md#the-tenure-ramp)). What the new member gets right away is the vote. Under this model, that doesn't wait. Workers on probation get a profit share too, in cash, at the rate of a member just starting out.

 ### No pushing people out before they'd join

@@ -92,7 +92,7 @@ Some things make it less harsh than it sounds:
 - **Whatever they built goes with them.** A member's account is paid out when they leave, and small balances are paid all at once ([Member Capital Accounts](capital-accounts.md#how-its-paid-out)).
 - **In care work, the profit is small anyway.** At home care's thin margins, a full share is worth a couple of thousand dollars a year, and a typical member's is less ([Member Capital Accounts](capital-accounts.md)). For these workers, most of what matters is pay, hours and a say in how the work is done.

-A co-op can choose the short end of the ramp. This page doesn't shorten it further, because the founding plan sets that range on purpose. A longer ramp is what lets a co-op hire without every new member cutting into everyone else's share right away. Whether low-margin, high-turnover co-ops should be allowed a much shorter ramp is an open question ([Open Problems](open-problems.md)).
+A co-op can choose the short end of the ramp. This page doesn't shorten it further, because the founding plan sets that range on purpose. A longer ramp was meant to let a co-op hire without every new member cutting into everyone else's share right away. Under tax law, it only does that if the co-op pays the difference as wages for years of service ([How a Locked Co-op Is Taxed](taxes.md#the-tenure-ramp)). Whether low-margin, high-turnover co-ops should be allowed a much shorter ramp is an open question ([Open Problems](open-problems.md)).

 ## What this doesn't solve

@@ -13,7 +13,7 @@ summary: A working model for building an economy where the people who do the wor

 This model doesn't buy, seize or convert anyone's company. Instead it builds new worker-owned companies alongside existing ones, then lets customers and workers choose between them.

- **Workers own their company.** Every member gets one vote. A share of the profits grows with tenure until long-time members split them equally. Salaries still exist, and hard jobs still pay more. Part of each year's profit builds up in a personal account that's paid out when you leave, and part goes into a permanent reserve that keeps the business investing. Members can't drain it through high pay or let the equipment quietly wear out, and big bets get an outside opinion first. An insurance pool the co-ops pay for protects workers' last paychecks and part of their savings if the co-op fails. A fair, fast process deals with members who won't do the work, with protections so it can't be turned on the wrong people. Membership comes automatically after a short probation, so co-ops in high-turnover work like home care don't end up run by the few who stay. Equal shares give members a reason to turn down growth into lower-paying work, so co-ops can grow by starting new co-ops they invest in instead. [Worker Ownership](worker-ownership.md), [Does Sharing the Profit Mean Less Effort?](free-riding.md), [When People Don't Stay Long](high-turnover.md), [When Growing Means Sharing](growth.md), [Member Capital Accounts](capital-accounts.md), [Protecting Members' Savings](savings-guarantee.md) and [Investing for the Long Run](the-long-run.md)
+- **Workers own their company.** Every member gets one vote. A share of the profits grows with tenure until long-time members split them equally, per hour worked, which is how federal tax law lets co-ops pay tax on it only once. Salaries still exist, and hard jobs still pay more. Part of each year's profit builds up in a personal account that's paid out when you leave, and part goes into a permanent reserve that keeps the business investing. Members can't drain it through high pay or let the equipment quietly wear out, and big bets get an outside opinion first. An insurance pool the co-ops pay for protects workers' last paychecks and part of their savings if the co-op fails. A fair, fast process deals with members who won't do the work, with protections so it can't be turned on the wrong people. Membership comes automatically after a short probation, so co-ops in high-turnover work like home care don't end up run by the few who stay. Equal shares give members a reason to turn down growth into lower-paying work, so co-ops can grow by starting new co-ops they invest in instead. [Worker Ownership](worker-ownership.md), [Does Sharing the Profit Mean Less Effort?](free-riding.md), [When People Don't Stay Long](high-turnover.md), [When Growing Means Sharing](growth.md), [Member Capital Accounts](capital-accounts.md), [How a Locked Co-op Is Taxed](taxes.md), [Protecting Members' Savings](savings-guarantee.md) and [Investing for the Long Run](the-long-run.md)
 - **A small public bank lends to worker co-ops.** It charges market rates, so it only succeeds if co-ops can really compete. Its whole job is to be willing to lend to a kind of company other banks won't. Spain, Italy and the US have all tried versions of this, and the pilot is built around what went right and wrong. [The Bank](the-bank.md) and [Has This Been Tried?](precedents.md)
 - **Owners who want to sell to their workers can.** The bank lends for these sales on a separate track, with its own $100 million and its own test. Only healthy firms qualify, there's no new tax break, the price is capped at an independent appraisal, the seller shares the risk, and the whole workforce votes. [When an Owner Wants to Sell to the Workers](buyouts.md)
 - **Co-ops funded this way stay co-ops forever.** They can't be sold to conventional owners, and members can't vote to cash out what earlier members built. An independent lock-holder can veto any attempt, including selling the business off piece by piece. If a co-op goes bankrupt, only another co-op can buy it whole, and its workers get a real chance to be that buyer. That needs an amendment to federal bankruptcy law, drafted here. [The Lock](the-lock.md), [When a Locked Co-op Goes Bankrupt](bankruptcy.md)
@@ -21,7 +21,7 @@ An honest list of what the model hasn't solved yet, most dangerous first.

 6. **Political durability.** *(Partly answered.)* Gradual construction invites gradual repeal. [Making It Last](durability.md) builds the bank to survive a hostile government: the lending standards and the test are fixed in law, board vacancies can't freeze lending, the verdict says "not tested" rather than "failed" if the bank turns away applicants who meet its own standards, and repeal can't unlock the co-ops. Still open: after the Supreme Court's 2026 ruling any president can replace the bank's board; money not yet lent can be taken back in a budget bill; the lock's bankruptcy protection depends on a federal law that can be repealed; and at pilot scale the sector has no real constituency.

-7. **Growth and dilution.** *(Partly answered.)* Softened by the tenure ramp, not eliminated. In steady state, an equal split per head still means a marginal hire must generate the average surplus to break even for incumbents. Capital-intensive expansion into lower-margin lines will face internal resistance conventional firms don't have. [When Growing Means Sharing](growth.md) makes Mondragon's answer the standard path: a lower-margin line becomes its own locked co-op, funded from the parent's reserve as a finite, voteless investment, under rules that stop it being used to push existing workers out or move money through insider deals. Still open: growth that can't be split off still dilutes, spin-offs create richer and poorer co-ops (the groups can pool profits, but don't have to), and the evidence comes from co-ops that could hire non-members, so it probably understates the problem under the lock.
+7. **Growth and dilution.** *(Partly answered.)* Softened by the tenure ramp, not eliminated, and federal tax law softens it less than the founding plan expected: by default, the part of a share new members haven't reached goes to the reserve, not to other members ([How a Locked Co-op Is Taxed](taxes.md#the-tenure-ramp)). In steady state, an equal split per head still means a marginal hire must generate the average surplus to break even for incumbents. Capital-intensive expansion into lower-margin lines will face internal resistance conventional firms don't have. [When Growing Means Sharing](growth.md) makes Mondragon's answer the standard path: a lower-margin line becomes its own locked co-op, funded from the parent's reserve as a finite, voteless investment, under rules that stop it being used to push existing workers out or move money through insider deals. Still open: growth that can't be split off still dilutes, spin-offs create richer and poorer co-ops (the groups can pool profits, but don't have to), and the evidence comes from co-ops that could hire non-members, so it probably understates the problem under the lock.

 8. **Who decides which sectors are "essential"?** *(Partly answered.)* Subsidy authority is price-setting power over a large chunk of the labor market, and every low-margin industry will suddenly discover it is Essential. [Who Decides What's Essential](essential-work.md) takes the choice away from people. A fixed formula decides: work qualifies only if public programs already pay for most of it and it pays badly. The money goes to workers by the hour, measured from records like Medicaid's visit logs, and states whose rates fall behind inflation lose federal Medicaid money in step. Still open: work mostly paid for by families, possibly including much child care, doesn't qualify; employers and owners may still capture some of the money; and it plausibly costs tens of billions of dollars a year.

@@ -31,6 +31,8 @@ An honest list of what the model hasn't solved yet, most dangerous first.

 14. **Drift toward the safest co-ops.** *(Partly answered.)* A bank that lends only to co-ops can still lend mostly to the safe ones, like consultancies started by people with savings, as America's co-op bank did. [Who the Bank Lends To](who-gets-loans.md) sets aside $90 million of the loan money for co-ops in lower-paid work, which goes back to the general pool only if the reviewers certify the bank handled those applications fairly. Results are reported for that group and for first-time owners without much wealth, and the verdict has to say which kinds of co-ops it covers. Still open: the set-aside makes money available but can't make groups apply; it can be used mostly on work just under the average wage; first-time owners without wealth get reporting, not money; and in work whose prices are set by Medicaid or contractors, a failure may say more about the price than about co-ops.

+15. **Taxes.** *(Partly answered.)* A locked co-op is a corporation that pays tax once on members' profit shares, under the part of the tax code written for co-ops. [How a Locked Co-op Is Taxed](taxes.md) fits the model to it: profit is shared per hour worked, workers who aren't members get a share too, wages reach the going rate before any profit is shared, and charges come out of the current year's share before older, already-taxed balances. Still open: nobody has ruled that a co-op with an outside lock-holder and a reserve that goes to the federation counts as a co-op for tax purposes; whether profit shares owe payroll tax is unsettled; the ramp no longer shields senior members from new hires unless it's paid as wages; workers without work authorization can't be members; and the kept reserve pays 21% even though nobody owns it.
+
 11. **Federal or state?** *(Mostly answered.)* The test stays federal, because one bank with one plan makes one clean experiment. Any state can copy the bank under the same published rules, reported separately, and a model state law protects the lock ([Making It Last](durability.md#federal-test-state-copies)). Still open: whether a few state lenders sharing one plan would have been the stronger experiment after all, since the most durable public bank in America, North Dakota's, is a state bank.

 12. **Voluntary buyouts: in or out?** *(Answered.)* In, on a separate track: $100 million of its own, healthy firms only, a willing seller, no new tax break, a capped price the seller shares the risk on, a vote of the whole workforce, and its own test of money and pay, so it can't flatter the startup result ([When an Owner Wants to Sell to the Workers](buyouts.md)). Still open: whether a price set by the market is fair to workers who pay it out of their own future work, and whether about 60 deals can show more than that the loans get repaid.
@@ -9,7 +9,7 @@ summary: Salaries in a co-op are set by its members, so the model guards against

 In this model, base salaries still exist, and the co-op sets them. Hard jobs and in-demand jobs pay more ([Worker Ownership](worker-ownership.md)). There's no legal cap on pay.

-That makes pay the one big lever the profit split doesn't control. Profit is divided by fixed rules: 30% to the reserve, then shares by each member's share weight, which grows with tenure until it's full ([Member Capital Accounts](capital-accounts.md)). Salaries are whatever the members decide. So a co-op's pay decisions can quietly undo the rest of the design, in two opposite ways.
+That makes pay the one big lever the profit split doesn't control. Profit is divided by fixed rules: 30% to the reserve, then shares by hours worked, times each member's share weight, which grows with tenure until it's full ([Member Capital Accounts](capital-accounts.md)). Salaries are whatever the members decide. So a co-op's pay decisions can quietly undo the rest of the design, in two opposite ways.

 ## Two ways pay goes wrong

@@ -0,0 +1,131 @@
+---
+title: How a Locked Co-op Is Taxed
+section: The Co-op
+order: 25
+summary: Federal tax law already lets worker co-ops pay tax on members' profit shares only once, but only if profit is shared by hours worked, so this page fits the model's rules to that law, says what it costs, and lists what the IRS or Congress still needs to confirm.
+---
+
+# How a Locked Co-op Is Taxed
+
+This model relies on an old part of the federal tax code, called Subchapter T, that lets co-ops pass profit to their members and have it taxed only once. Get the details wrong and a co-op pays tax twice on the same profit, which would sink the test for reasons that have nothing to do with whether co-ops work. This page works through those details. It describes federal law as it stands in 2026. It isn't tax advice, and each co-op's bylaws need a tax lawyer's review.
+
+## How co-ops are taxed today
+
+An ordinary corporation pays 21% federal tax on its profit ([26 U.S.C. § 11](https://www.law.cornell.edu/uscode/text/26/11)). When it pays what's left to shareholders as dividends, they pay tax again.
+
+A corporation run as a co-op can skip the first tax on the profit it pays back to the people it does business with, called **patronage dividends** ([§ 1382](https://www.law.cornell.edu/uscode/text/26/1382)). They pay income tax on them instead ([§ 1385](https://www.law.cornell.edu/uscode/text/26/1385)). To count, a patronage dividend has to be ([§ 1388](https://www.law.cornell.edu/uscode/text/26/1388)):
+
+- **Paid according to how much business each person did with the co-op.** In a worker co-op, the "business" is work, and most US worker co-ops divide profit by hours worked ([Democracy at Work Institute guide](https://institute.coop/sites/default/files/resources/Internal-Capital-Accounts.pdf)). The Tax Court accepted a plywood co-op's split by hours in 1965 (*Puget Sound Plywood v. Commissioner*, 44 T.C. 305), though that case was decided under the law before Subchapter T. Today's practice rests on the IRS accepting it since.
+- **Owed under rules set before the profit was made,** like bylaws adopted in advance.
+- **Not taken from other people's share.** A patronage dividend can't include money from the business of people who got nothing, or got less for the same thing ([§ 1388(a)](https://www.law.cornell.edu/uscode/text/26/1388)). The Treasury's example: if a co-op pays nothing to its non-member customers, the part of members' dividends that came from business with them isn't a patronage dividend ([26 C.F.R. § 1.1388-1(a)(2)](https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFRc609157f1a908c0/section-1.1388-1)). That part is taxed twice.
+
+Money kept in members' [capital accounts](capital-accounts.md) counts too, if at least 20% of each dividend is paid in cash and the member has agreed to be taxed on the rest now. A bylaw can make membership count as agreement, but only if each member gets a written notice and a copy of the bylaw ([§ 1388(c)](https://www.law.cornell.edu/uscode/text/26/1388)). With automatic membership ([When People Don't Stay Long](high-turnover.md)), that notice is handed over, and signed for, when someone joins. Everything has to be paid or credited within eight and a half months after the year ends.
+
+**The reserve is taxed.** Profit the co-op keeps for itself isn't paid to anyone, so the co-op pays the 21% on it. US worker co-ops that keep a permanent reserve already work this way ([Democracy at Work Institute guide](https://institute.coop/sites/default/files/resources/Internal-Capital-Accounts.pdf)).
+
+**In the standard example** from [Member Capital Accounts](capital-accounts.md#where-each-years-profit-goes), a co-op makes $600,000. The $360,000 paid to members is taxed once, on their own returns. The $180,000 for the reserve is taxed at 21%, about $37,800, so about $142,000 is actually saved. If the $60,000 paid to the federation fund can't be deducted, the tax is about $50,400. Whether it can depends on how the federation is set up (see below).
+
+## Why a locked co-op is a corporation
+
+Many small businesses are partnerships, or LLCs taxed as partnerships, which pay no business-level tax. That doesn't work here, for two reasons:
+
+- **Partners can't be employees.** The IRS treats partners as self-employed, not as employees of their own partnership ([IRS, Publication 541](https://www.irs.gov/publications/p541); [IRS practice unit](https://www.irs.gov/pub/fatca/int_practice_units/self-employment-tax-partners.pdf)). [The pilot](pilot-spec.md#who-can-borrow) requires members to be on the payroll, so they have minimum wage, unemployment insurance and workers' compensation.
+- **Partners are taxed on all the profit, including what's kept.** Members would owe tax each year on their share of a reserve they can never take out.
+
+So a locked co-op is a corporation, or an LLC that chooses to be taxed as one ([26 C.F.R. § 301.7701-3](https://www.law.cornell.edu/cfr/text/26/301.7701-3)), and files the co-op version of the corporate tax return.
+
+## Does a locked co-op count as a co-op?
+
+Subchapter T applies only to a corporation "operating on a cooperative basis" ([§ 1381](https://www.law.cornell.edu/uscode/text/26/1381)). Courts and the IRS read that as three things: members control it democratically, capital doesn't control it or take its profits, and profit goes back to the people who did business with it, according to how much they did. If a co-op fails this test, it loses Subchapter T entirely, not just one dividend.
+
+Two features of this model could strain the test:
+
+- **The lock-holder.** An outside organization holds a share that can veto a sale ([The Lock](the-lock.md)). But that share carries no profit and no say in running the business. It only blocks the co-op from being sold.
+- **The reserve goes to the federation, not the members, if the co-op closes.** Some US worker co-ops already write this into their bylaws, sending leftover assets to groups that support co-ops ([Democracy at Work Institute guide](https://institute.coop/sites/default/files/resources/Internal-Capital-Accounts.pdf)). But no ruling covers it for this model's co-ops.
+
+This is the first question for the IRS, and for Congress (see [Getting certainty](#getting-certainty)).
+
+## The model's rules, fitted to the law
+
+### What counts as an hour
+
+Profit shares follow hours, so hours have to be defined in advance, in the bylaws:
+
+- **Hours paid**: hours worked, as wage law counts them, plus paid leave and state paid family leave.
+- **Salaried staff count 40 hours a week.** Overtime counts once, not time and a half. No one counts more than 2,080 hours a year.
+- **Only hours on the payroll records** that match the co-op's quarterly payroll tax filings. Time on committees and the board counts only up to a small share of a person's hours. The co-op's auditor checks a sample of timesheets each year.
+
+Unpaid leave, even protected leave, isn't paid hours. Crediting hours nobody worked could mean paying one person out of another's work, which the rule above forbids. So a co-op that wants leave to count has to offer paid leave. Time on leave still counts toward the ramp, as [Worker Ownership](worker-ownership.md) promises.
+
+### Wages first
+
+Before any profit is shared, every worker is paid at least the going rate for their job for their hours ([Investing for the Long Run](the-long-run.md#the-rules)). If the year's wages fell short, the shortfall is paid first, as wages.
+
+Why: members are employees. If a co-op paid itself low wages and large profit shares, the IRS could say the profit shares are really wages in disguise, and owe payroll tax (Social Security and Medicare) and penalties. That's the same argument the IRS uses against small-business owners who pay themselves too little salary. Paying the going rate first makes the profit share clearly profit. It also helps low-paid members: wages count toward the Earned Income Tax Credit and Social Security, and profit shares don't.
+
+### One rate per hour, for everyone who works
+
+The members' profit pool is divided by hours worked. Before the ramp, every hour earns the same amount, and "everyone's share is identical" means identical **per hour**. A part-timer who got the same check as a full-timer would be collecting from the full-timer's work.
+
+**Non-members get a share too.** The tax law's word is "patron," not "member," so people on probation, and people who chose not to join, can receive patronage dividends. In this model they get the same share per hour as a member starting the ramp, all in cash. The rest of what their hours earned goes to the reserve, on top of the 30% minimum. The reserve still benefits the co-op, which members govern, but no member's own check comes from a non-member's work. Hiring non-members can't raise members' profit shares.
+
+### The tenure ramp
+
+The founding plan has a new member start at a partial profit share and reach a full one over five to ten years ([Worker Ownership](worker-ownership.md)). As first written, the part a new member didn't get went to the other members. The tax law doesn't allow that: a new member and a ten-year member who work the same hours are doing the same business with the co-op, so the ten-year member can't be paid out of the new member's work without that part being taxed twice.
+
+**So the ramp's unpaid part goes to the reserve.** A member at half a share gets half the per-hour amount. The other half goes to the reserve, on top of the 30% minimum.
+
+**What that costs, in the standard example.** Say the 40 members are 32 at a full share and 8 new members at half a share, all working the same hours. As first written, full members got $10,000 and new members $5,000. Now the $360,000 pool is $9,000 for each member's hours. Full members get $9,000. New members get $4,500, and the other $4,500 of each, $36,000 in all, goes to the reserve, which gets $216,000 instead of $180,000. If new members work fewer hours than the others, the full members lose less. In a co-op where few members are new, they lose little.
+
+That changes what the ramp does. The founding plan's reason for it was to stop every new hire from cutting into everyone else's share. Now it doesn't do that: a new member's hours count in dividing the pool from the start. What the ramp still does is make new members earn their way to a full share, with the difference building up the co-op's own reserve instead of senior members' checks.
+
+**Two other ways, both with costs.** A co-op can choose either in its bylaws, before the year starts:
+
+- **Pay the ramp as a wage for years of service.** Everyone gets the per-hour profit share at the starting rate. Senior members get the rest as a pay supplement for years of service, which employers can pay and deduct. That keeps the founding plan's shield for senior members, but it costs payroll tax, about 15% split between the co-op and the member, on most of the profit share. And wages can't be held in capital accounts, so the accounts, and the money the co-op can reinvest from them, shrink.
+- **Ask the IRS to accept the old result.** The unpaid part could count toward the reserve's 30% minimum, which lets the co-op put that much more into the members' pool, so senior members get what they did before. But then senior members gain exactly what new members give up, and the IRS could fairly say it's the old formula by another route. It's only an option if the IRS rules that it's allowed.
+
+### Capital accounts
+
+- **The usual way.** Members agree to be taxed now on what's credited to their accounts, and at least 20% is paid in cash. The model's default is half in cash, which covers the tax for most members.
+- **Members with lower incomes can choose not to be taxed until they're paid.** The law allows a second kind of credit, a "nonqualified" notice. The co-op pays the 21% now and gets it back as a deduction when the account is paid out, and the member pays tax only when they receive the money ([§ 1382(b)(2)](https://www.law.cornell.edu/uscode/text/26/1382)). That's the default for members under twice the poverty line who leave money in their accounts. They can still take their whole share in cash instead ([Member Capital Accounts](capital-accounts.md)).
+- **Charges come out of this year's share first.** Money members already paid tax on can be moved back to the reserve, under [the pay rule](the-long-run.md#the-rules) or when losses are charged to accounts. That's probably taxable to the co-op a second time, and the member may be able to deduct only part of it. So those charges come out of the current year's profit share first, before it's credited or taxed, and reach older balances only when that isn't enough. Credits to accounts that are likely to be charged later can be made as nonqualified notices.
+
+## Payroll tax on profit shares
+
+Wages carry payroll tax, about 15% in all, split between the co-op and the worker. Whether patronage dividends paid to worker-members do too is unsettled. The likelier challenge is that profit divided by hours worked is really wages. A second theory is that it's self-employment income. The IRS has claimed the second against members of at least one worker co-op, then backed down when challenged, without a published explanation ([Gregory Wilson, co-op tax lawyer](http://www.gwilson.com/documents/Article4(PatronageDivTax).pdf)). His argument: a member paid a fair wage through payroll is like a shareholder who works for the company, and a shareholder's dividends don't carry payroll tax. The wages-first rule is built to support that argument.
+
+If the IRS wins, members pay about 15% more on their profit shares. Low-paid members would at least earn Social Security credit and Earned Income Tax Credit on it.
+
+## Benefits
+
+Profit shares count as income for Medicaid, health insurance subsidies, food assistance and housing aid, even when they're kept in an account. A lump sum can push a family over a limit for a month or a year. So:
+
+- the lower-income defaults above keep account credits from counting until they're paid;
+- members can ask for their payout when they leave in installments, so one payment doesn't push them over a limit for savings, like the one for Supplemental Security Income;
+- the federation offers benefits advice to every member, along with the templates and training it already supplies ([The Federation](federation.md)).
+
+## Getting certainty
+
+The IRS gives binding answers on specific facts, called private letter rulings, but only to the taxpayer who asks, only about its own real transactions, and never as precedent for anyone else ([26 U.S.C. § 6110(k)(3)](https://www.law.cornell.edu/uscode/text/26/6110)). A ruling costs a fee and often takes months, and the IRS can decline to give one. So:
+
+- **The first pilot co-ops ask, and the bank pays.** They ask whether the co-op operates on a cooperative basis with the lock and the reserve, whether the per-hour profit shares and the ramp count as patronage dividends, whether profit shares carry payroll tax when wages meet the going rate, and how charges moved back to the reserve are taxed.
+- **Until then, every co-op uses the rules on this page, and gets a tax lawyer's opinion on its bylaws.** None of them depends on a ruling to work.
+- **Congress settles it.** The bank's own law needs Congress anyway, and so does [the bankruptcy amendment](bankruptcy.md). That law also says a locked co-op that meets these rules operates on a cooperative basis, and that its profit shares aren't wages for members paid at least the going rate. That's a statement of how existing law applies, not a lower tax rate.
+
+## How this compares with other businesses
+
+A co-op isn't taxed more lightly than other small businesses, and it isn't taxed much more heavily either:
+
+- **Profit paid to members** is taxed once, at their own rates. Owners of partnerships and S corporations (small corporations taxed like partnerships) are taxed the same way on the profit they take.
+- **Profit the co-op keeps** is taxed at 21% and never again, because nobody can ever take it out. A conventional corporation's kept profit is taxed at 21% and again when it's paid out. A partnership's or S corporation's owners are taxed on it at their own rates, which can be higher or lower, and they own it.
+- **The difference that matters:** a conventional owner's kept profit is still theirs. The co-op's reserve belongs to no one, and it still pays tax. That's a cost of the lock, and this model doesn't ask for a tax break to cover it.
+
+## What this doesn't solve
+
+- **The ramp no longer shields senior members.** Under tax law, the founding plan's reason for the ramp works only through the reserve, through payroll tax, or with the IRS's blessing. Which is best is open.
+- **Workers without work authorization can't be members.** Being on the payroll requires it. Some immigrant cleaning co-ops today are partnerships partly so members with only a taxpayer number can be owners. This model can't do that without giving up payroll protections, and it leaves those workers out.
+- **Unpaid leave costs profit share.** Mostly for women, unless the co-op pays for leave.
+- **States differ.** Most states follow the federal treatment of co-ops. But some tax a business's gross receipts, like Ohio and Washington, where the patronage deduction doesn't help. And some states' co-op laws may send leftover assets to members when a co-op closes, which would clash with the lock. Each pilot state needs checking.
+- **The federation's form matters.** If the federation fund is a charity, a co-op's payments and a closing co-op's reserve are gifts, and corporations can deduct gifts only up to a limit ([§ 170(b)(2)](https://www.law.cornell.edu/uscode/text/26/170)). If it's a trade association, payments may be deductible as a business expense. The choice isn't made.
+- **Interest on accounts may not be deductible.** The formula pays extra interest only in profitable years, which could make it look like a dividend on capital. If so, it's paid from taxed profit.
+- **It's a lot of paperwork.** A co-op tax return, a patronage form for every worker, written notices, consent records, hours tracking, and the ramp. The federation provides standard software and filing help at cost, and the pilot's business help pays for setting it up.
@@ -69,7 +69,7 @@ That leaves four ways the horizon problem can still get in.
 - **Why a single adult's living wage.** In Salt Lake City in 2026, MIT puts the living wage at $24.64 an hour for a single adult and $41.55 for one adult supporting a child. An earlier version of this rule let pay up to one and a half times the second figure, about $130,000 a year, count as "raising the bottom." That would have let a co-op pay every cleaner six figures without the reserve getting anything. The single-adult figure, about $51,000 a year there, is still well above what most aides earn. Paying more than that is allowed. The reserve just takes its 30% of the difference.
 - **It's checked job by job.** Paying one group below the going rate doesn't make room to pay another group above it. An outside reviewer, the co-op's auditor or the bank's, assigns each person the occupation code for the work they spend most of their hours on, not their title, and the codes are shown to members next to each job. Where the survey has no figure for the metro area, the state figure is used, then the national one.
 - **It counts total pay.** Employer retirement contributions above 6% of pay, bonuses, severance beyond two weeks' pay per year worked (up to 26 weeks), and perks like a car, housing or loans to members, valued at cost, all count as pay. So does pay to non-members and to people working through a related company, and the value of any deal with a member or their family on better than market terms, like buying from a relative's firm above the market price. Co-ops can't promise pensions or retiree benefits they don't pay for in full each year.
- **How it's settled.** Thirty percent of the excess is moved from members' [capital accounts](capital-accounts.md) into the reserve. No new cash has to be found, because the members already took that money as pay. If a member's account can't cover it, the rest comes out of their future account credits, or out of their payout when they leave. For pay to non-members, it comes out of that year's members' profit pool.
+- **How it's settled.** Thirty percent of the excess goes to the reserve, first out of the member's profit share for that year, before it's paid or credited, and then out of their [capital account](capital-accounts.md). No new cash has to be found, because the members already took that money as pay. Taking it from this year's share first avoids a second round of tax on money already credited ([How a Locked Co-op Is Taxed](taxes.md#capital-accounts)). If that isn't enough, the rest comes out of their future account credits, or out of their payout when they leave. For pay to non-members, it comes out of that year's members' profit pool.
 - **There's a precedent.** US tax law already treats salaries that aren't "reasonable" as disguised profit ([26 U.S.C. § 162(a)(1)](https://www.law.cornell.edu/uscode/text/26/162)), so owners can't dodge tax by calling profit pay. This rule stops the same disguise being used to dodge the reserve. The tax test is judged case by case. This one is a fixed formula, so it's cruder but much harder to argue about.

 **2. Gains from selling assets go to the reserve.** If a co-op sells a building, equipment, a brand or a patent for more than its value on the books, the whole gain goes to the reserve, not into the profit split. A sale to an insider, or a sale-and-lease-back, is checked like any [insider deal](pilot-safeguards.md#the-hidden-boss).
@@ -88,7 +88,7 @@ That leaves four ways the horizon problem can still get in.
 - **If the year ends in a loss,** the part of the loss up to the pay above the going rate, in that year and the year before, is charged to the people who got that pay, in proportion to how much each got. It comes out of their [capital accounts](capital-accounts.md), and out of their payouts if they've left since. The 30% rule 1 already moved from their accounts counts toward it, so nobody pays twice. The rest of the loss is shared as usual.
 - **An example.** A co-op loses $50,000. Its managers were paid $30,000 above the going rate that year, and rule 1 already moved $9,000 of that into the reserve. The managers' accounts are charged $21,000 more. The other $20,000 of the loss is shared between the reserve and all members' accounts in the usual way.
 - **What their accounts can't cover** comes out of their future profit shares, above the cash they need for tax, and nobody's above-going-rate pay can rise until it's repaid. After three years, anything still owed is written off.
- **Pay above the going rate to non-members** is charged to all members by share weight (how much of the profit each member gets), since members chose to pay it. Members whose household income is under twice the poverty line are left out, and so is the insured slice of anyone's account.
+- **Pay above the going rate to non-members** is charged to all members in proportion to their profit shares, since members chose to pay it. Members whose household income is under twice the poverty line are left out, and so is the insured slice of anyone's account.
 - **It never touches pay already earned.** Wages and bonuses already paid or earned stay paid. The charge falls on savings in the co-op, not paychecks.

 Without this rule, members could vote themselves high pay, run the co-op at a loss, and let the losses eat the reserve once their own accounts ran dry. That would be withdrawing the reserve by another name, which [the lock](the-lock.md) forbids. The cost is real too. In an honest bad year, the best-paid people lose some savings, and some may leave.
@@ -15,6 +15,8 @@ A worker co-op under this model means two things, and they are not the same thin

 Why the ramp: it kills the dilution panic. Under flat equal shares, every new hire immediately eats everyone's slice, and cooperatives empirically under-hire for exactly that reason. With a ramp, hiring decisions move toward "does this person grow the pie" during precisely the window when their value is most uncertain. The ramp only softens the problem, though. How co-ops can grow into lower-margin work without shrinking everyone's share is in [When Growing Means Sharing](growth.md).

+Federal tax law narrows what the ramp can do. Profit shares are counted per hour worked, and the part of a share a new member hasn't reached yet can't go to the other members without being taxed twice. So by default it goes to the co-op's permanent reserve. The ramp still makes new members earn their way to a full share, but it no longer protects everyone else's share from new hires, unless a co-op pays the difference as wages for years of service ([How a Locked Co-op Is Taxed](taxes.md#the-tenure-ramp)).
+
 Protected leave (parental, medical, caregiving) counts as tenure, so taking time off to care for someone doesn't set your share back. So does earlier time at the same co-op: someone who leaves and comes back within a few years picks up where they left off.

 Membership itself comes automatically after a short probation, unless a worker opts out. In jobs like home care, where most people move on within a year or two, that's what keeps a co-op from becoming a club of the few who stay ([When People Don't Stay Long](high-turnover.md)).