4 changed files with 18 additions and 5 deletions
@@ -45,7 +45,7 @@ Members can also raise their own salaries instead of taking profit, but that doe

 ## How the account grows

- **Interest is set by formula, not by vote.** A current member's account earns the one-year Treasury rate plus two percentage points in years the co-op makes a profit, and the plain Treasury rate in loss years. Once a member leaves, their balance earns the plain Treasury rate. So does the slice of a current member's account that's protected by [insurance](savings-guarantee.md), since it's no longer at risk. If current members voted on the rate, they could set it to zero on accounts that mostly belong to people who've left. Or senior members could set it high to pay themselves out of the firm. A formula stops both.
+- **Interest is set by formula, not by vote.** A current member's account earns the one-year Treasury rate plus two percentage points, every year. It's credited after the co-op's tax on it, since the co-op can't deduct it ([How a Locked Co-op Is Taxed](taxes.md#interest-on-accounts)). Once a member leaves, their balance earns the plain Treasury rate. So does the slice of a current member's account that's protected by [insurance](savings-guarantee.md), since it's no longer at risk. If current members voted on the rate, they could set it to zero on accounts that mostly belong to people who've left. Or senior members could set it high to pay themselves out of the firm. A formula stops both.
 - **Why the extra two points.** Money in a current member's account is at risk: it shares in losses and ranks behind lenders. If it only earned what a risk-free government bond pays, members would vote to pay out as much in cash as the rules allow, and the co-op would have less of its own money to invest. Once you leave, your balance stops sharing in losses, so it stops earning the premium. See [Investing for the Long Run](the-long-run.md#the-rules).
 - **Losses are shared.** In a year the co-op loses money, the loss is charged partly to the reserve and partly to members' accounts, in the same proportions as profits. Your account can go down, just like shares in any company.

@@ -31,7 +31,7 @@ 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, half of it for the lowest-paid industries, 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; within each half it can be used mostly on the better-paid end; "lower-paid" is judged by industry, which leaves out poorly paid co-ops in well-paid industries and can be gamed by how a co-op describes its work; 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. Even measuring who gets loans needs its own rule: lending rules bar asking applicants' race and sex, and the federal exception for small-business lenders won't reach a bank this small, so the bank's law has to require the question, and a later Congress could drop it ([Asking needs its own legal basis](who-gets-loans.md#treated-the-same)).

-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; the kept reserve pays 21% even though nobody owns it; following the deferred-pay rules for lower-income members' untaxed credits could be read as conceding that the credits are pay; and a member who loses their account when a co-op fails can probably deduct only $3,000 a year of it, after being taxed on it in full, until Congress refunds that tax.
+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; the kept reserve pays 21% even though nobody owns it; the return on members' accounts probably can't be deducted, so account holders' returns are credited after the co-op's tax ([Interest on accounts](taxes.md#interest-on-accounts)); following the deferred-pay rules for lower-income members' untaxed credits could be read as conceding that the credits are pay; and a member who loses their account when a co-op fails can probably deduct only $3,000 a year of it, after being taxed on it in full, until Congress refunds that tax.

 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 for co-ops that choose it ([The Lock in State Law](lock-state-law.md); [Making It Last](durability.md#federal-test-state-copies)). No state has adopted anything like it, and a co-op organized in a state that hasn't relies on its charter alone. 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.

@@ -101,6 +101,19 @@ That changes what the ramp does. The founding plan's reason for it was to stop e
 - **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 will be the default for members under twice the poverty line who take the standard split. It waits for the Labor Department's answer on pension law, because an untaxed credit a member chooses in advance looks most like the deferred-pay plans courts have called pension plans ([Member Capital Accounts](capital-accounts.md#why-not-pay-it-out-when-you-leave)). Until then, those members take their whole share in cash by default, or the standard split, taxed now. These credits follow extra timing rules, [below](#credits-taxed-later-the-deferred-pay-rules).
 - **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.

+### Interest on accounts
+
+Accounts earn a return by formula ([Member Capital Accounts](capital-accounts.md#how-the-account-grows)): the one-year Treasury rate plus two points while a member works there, the plain Treasury rate after they leave. How that's taxed depends on whether an account is a debt the co-op owes or an owner's stake in it.
+
+- **A business deducts interest only on a debt** ([26 U.S.C. § 163(a)](https://www.law.cornell.edu/uscode/text/26/163)). The factors the tax code lists for telling a debt from an owner's stake include an unconditional promise to pay a fixed sum on a set date at a fixed rate, and whether the money ranks behind the business's other debts ([§ 385(b)](https://www.law.cornell.edu/uscode/text/26/385)).
+- **An account is an owner's stake.** It shares in losses, ranks behind lenders, and its payouts can be paused. So its return is probably a return on capital, not deductible interest, even after the member leaves. Co-ops can deduct dividends on capital only if they're tax-exempt farm co-ops ([§ 1382(c)(1)](https://www.law.cornell.edu/uscode/text/26/1382), [§ 1381(a)](https://www.law.cornell.edu/uscode/text/26/1381)). For everyone else, the Treasury's rule is that the profit split by patronage is what's left *after* dividends on "capital stock or other proprietary capital interests" ([26 C.F.R. § 1.1388-1(a)(1)](https://www.law.cornell.edu/cfr/text/26/1.1388-1)). So the co-op pays its 21% on the return first.
+- **The return is paid every year, not just in profit years.** The model used to pay the extra two points only when the co-op made a profit. That made it look like capital taking a share of the profit, which is one of the things the test for being a co-op at all rules out ([above](#does-a-locked-co-op-count-as-a-co-op)). A fixed, capped rate paid in good years and bad is how co-ops have long paid capital. It's credited to the account, not paid in cash, so a loss year doesn't cost the co-op cash.
+- **Account holders pay the tax on their own return.** The return is credited after the co-op's 21% tax on it. With the Treasury rate at 4%, a current member's 6% is credited as about 4.7%, and a former member's 4% as about 3.2%. Otherwise members who take all their share in cash, as lower-income members can, would pay part of the tax on other people's savings.
+- **The return itself comes off the top.** Because it's paid before the patronage split, the reserve, the federation fund and everyone's per-hour share all carry it. In the standard example, a co-op making $600,000 credits at most $180,000 a year to accounts, so after five years at most about $900,000 is waiting to be paid out. At 6%, that's at most about $54,000 a year, less in practice, since newer members, all-cash members and the insured slice (which earns the plain rate) hold less. A member with no account carries at most about $800 a year of it. That's the price of the capital the whole co-op uses instead of borrowing it, and it's published every year, per hour worked and per dollar in accounts.
+- **Members are probably taxed when they're paid, not when it's credited.** The money can't be touched until then. When it's paid, it's probably a dividend. A worker co-op isn't a tax-exempt corporation, so it may count as a "qualified" dividend, taxed at the lower rates for investment income, which are zero for many lower-paid members ([§ 1(h)(11)(B)](https://www.law.cornell.edu/uscode/text/26/1)). So the second tax is often small. But crediting some members' accounts while others take cash could be treated as a payment when it's credited ([§ 305(b)(2), (c)](https://www.law.cornell.edu/uscode/text/26/305)). That goes on the list for the IRS ([below](#getting-certainty)).
+- **If the IRS says the return breaks the co-op test,** the premium drops to the plain Treasury rate automatically, under the bylaws, for returns not yet credited.
+- **Why not make a former member's balance a debt?** It looks like a way to make their interest deductible, but it doesn't hold up. Interest that can be paused isn't "unconditionally payable," so it would be taxed each year before it's paid anyway ([26 C.F.R. § 1.1273-1(c)](https://www.law.cornell.edu/cfr/text/26/1.1273-1); [§ 1272(a)](https://www.law.cornell.edu/uscode/text/26/1272)). A note running several years must pay at least the federal rate for its term, which can be above the one-year rate ([§ 1274(d)](https://www.law.cornell.edu/uscode/text/26/1274)). Interest that can't be paused would pay people who left ahead of those who stayed, which the pause rules forbid. And a balance that turns loss-proof the day someone quits rewards quitting just before a bad year. The deduction isn't worth that.
+
 ### Credits taxed later: the deferred-pay rules

 A nonqualified credit isn't taxed until it's paid, years after the work. Federal tax law has strict rules for pay that's put off like that ([26 U.S.C. § 409A](https://www.law.cornell.edu/uscode/text/26/409A)). They cover only pay for services, and the model's position is that a profit share is an owner's share, not pay ([Owners Are Still Workers](labor-law.md#is-the-profit-share-pay)). Nobody has decided whether they reach a co-op's patronage credits. So the model follows them as a precaution, and the bylaws say it does so without conceding that they apply. Breaking them would be expensive for exactly the members this option exists to help. Everything put off becomes taxable at once, with interest and an extra 20% tax (§ 409A(a)(1)(B)). So once nonqualified credits are offered:
@@ -180,7 +193,7 @@ The model doesn't shrink the benefit cliffs themselves. A low-paid member on sev

 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 the founding share is deductible as pay, whether profit shares carry payroll tax when wages meet the going rate, how charges moved back to the reserve are taxed, and whether the deferred-pay rules, or the payroll-tax rule for deferred pay ([26 U.S.C. § 3121(v)(2)](https://www.law.cornell.edu/uscode/text/26/3121)), apply to nonqualified credits at all.
+- **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 the founding share is deductible as pay, whether profit shares carry payroll tax when wages meet the going rate, how charges moved back to the reserve are taxed, whether the return on accounts strains the cooperative test and when members are taxed on it, and whether the deferred-pay rules, or the payroll-tax rule for deferred pay ([26 U.S.C. § 3121(v)(2)](https://www.law.cornell.edu/uscode/text/26/3121)), apply to nonqualified credits at all.
 - **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 part is a statement of how existing law applies, not a lower tax rate. The same law also makes one real change, open to any employer's workers: it refunds the tax they paid on money they lose when their employer fails ([If the co-op fails](#if-the-co-op-fails)).

@@ -199,5 +212,5 @@ A co-op isn't taxed more lightly than other small businesses, and it isn't taxed
 - **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.
+- **The return on accounts isn't deductible.** It's most likely a return on capital, so the co-op pays 21% on it, charged to the accounts that earn it, and members may pay tax again when they're paid ([Interest on accounts](#interest-on-accounts)).
 - **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.
@@ -89,7 +89,7 @@ That leaves four ways the horizon problem can still get in.
 - **Limits.** The total cost still waiting to be charged can't exceed half of the co-op's average profit over the last three years, measured before any spreading. Only co-ops with an independent audit can use the rule, and the auditor checks each open project every year. The lighter review small co-ops get otherwise doesn't count ([What the Rules Cost a Small Co-op](compliance.md#what-a-review-can-and-cant-stand-in-for)).
 - **It only changes how costs are divided between this year's members and future ones.** It doesn't touch the co-op's tax return or its reports to the bank. The co-op publishes both numbers side by side.

-**4. Accounts earn a fair rate while they're at risk.** A current member's account earns the one-year Treasury rate plus two percentage points, credited in years the co-op makes a profit. In a loss year it earns the plain Treasury rate. Money in a current member's account is at risk: it shares in the co-op's losses and ranks behind its lenders. Paying only a risk-free rate on it would push every member to take cash instead. **Once a member leaves, the balance earns the plain Treasury rate.** It no longer shares in losses, so it's no longer at risk, and nobody should collect a premium from the work of people they no longer work alongside. For comparison, Italian law lets co-ops pay members up to 2.5 points above the rate on its postal savings bonds on the capital they've put in (Lomuscio and Tortia, 2023), and Mondragon paid 6% plus an adjustment for inflation (Morris, 1992). The details are on the [capital accounts page](capital-accounts.md#how-the-account-grows).
+**4. Accounts earn a fair rate while they're at risk.** A current member's account earns the one-year Treasury rate plus two percentage points, credited every year, good or bad, so it's a fixed return on capital and not a share of profit ([How a Locked Co-op Is Taxed](taxes.md#interest-on-accounts)). Money in a current member's account is at risk: it shares in the co-op's losses and ranks behind its lenders. Paying only a risk-free rate on it would push every member to take cash instead. **Once a member leaves, the balance earns the plain Treasury rate.** It no longer shares in losses, so it's no longer at risk, and nobody should collect a premium from the work of people they no longer work alongside. For comparison, Italian law lets co-ops pay members up to 2.5 points above the rate on its postal savings bonds on the capital they've put in (Lomuscio and Tortia, 2023), and Mondragon paid 6% plus an adjustment for inflation (Morris, 1992). The details are on the [capital accounts page](capital-accounts.md#how-the-account-grows).

 **5. The reserve doesn't pay for high pay in a loss year.** Mondragon calls its members' pay *anticipos*, advances on profits ([Morris, 1992](https://www.ilsr.org/wp-content/uploads/2013/03/mondragon-3.pdf)). This model treats the part of pay above the going rate the same way: as an advance against profit that hasn't been earned yet.