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title	section	order	summary
How a Locked Co-op Is Taxed	The Co-op	25	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). 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). They pay income tax on them instead (§ 1385). To count, a patronage dividend has to be (§ 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). 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)). 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)). That part is taxed twice.

Money kept in members' capital accounts 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)). With automatic membership (When People Don't Stay Long), 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).

In the standard example from Member Capital Accounts, 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; IRS practice unit). The pilot requires members to be on the payroll, so they have minimum wage and workers' compensation, and unemployment insurance in most states (Owners Are Still Workers).
• 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), 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). 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). 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). 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).

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 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). 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). 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.

The founding share

The Founder Problem sets aside 10% of the members' pool for the first ten years for the people who worked there in the first three years. Paid as a profit share, it would likely fail the patronage test. The rules exclude amounts paid out of other patrons' earnings to people doing "substantially identical transactions" (Treas. Reg. § 1.1388-1(a)(2)(ii)), and a founder and a later hire working the same hours in the same year are doing much the same business with the co-op. Some worker co-ops measure patronage by wages instead of hours, which could change that. This model uses hours (One rate per hour).

So it's paid as pay, in the year it's earned, and only to people still working there that year.

• Deferred-pay rules. Pay that vests by working the year and is paid soon after that year ends is generally not "deferred" under the rules for deferred pay (26 C.F.R. § 1.409A-1(b)(4)). Paying it only to people still there, each year, is meant to fit that. The standard bylaws still need a tax lawyer's review.
• Reasonable pay. It's pay set as a share of profit, and the IRS can treat unreasonable pay to owners as a disguised dividend (26 U.S.C. § 162(a)(1)). The cap, no more than the going-rate pay for the person's job each year, keeps a founder's total at most about double the going rate. The first pilot co-ops include it in their ruling request (below).
• Overtime. For hourly workers it's a bonus they're owed, so it counts in their overtime rate for the year it's paid.
• It costs payroll tax, paid by the co-op and the person, and it's paid in cash, since wages can't be held in capital accounts.

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)). That's the default for members under twice the poverty line who take the standard split. They can take their whole share in cash instead (Member Capital Accounts). These credits follow extra timing rules, below.
• 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 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 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). 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). 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 for nonqualified credits:

• Only co-ops using the federation's software offer them. The rules below are easy to get wrong by hand. In other co-ops, lower-income members choose between all cash and the standard split, taxed now.
• Only lower-income members get them, by a choice made before the year starts. A member chooses between the standard split and all cash by the end of the year before, and the choice holds for the whole year (26 C.F.R. § 1.409A-2(a)(3)). A new member can choose within 30 days of joining, and then it covers only profit from hours worked after the choice (§ 1.409A-2(a)(7)). The same choice fixes how the credit will be paid: at once, or in monthly payments that all fall in one calendar year. Whether a member is under twice the poverty line is judged on the higher of the last two years' household income, from their tax returns, so one low year doesn't qualify. The co-op can't decide after a year ends which credits are nonqualified.
• The schedule is fixed before the year starts. A vote to change the wait applies to nonqualified credits only for profit from years that start after the vote.
• They're paid unless paying would put the co-op at risk. Deferred pay can be held back past its date only if paying it would threaten the employer's ability to keep going, and then it has to be paid in the first year it wouldn't (§ 1.409A-3(d)). That's narrower than the co-op's ordinary solvency test, which also pauses payouts that would break its loan terms or its minimum cash level. So by December 1 each year, the co-op's outside accountant looks at the last checked accounts and a forecast, and says in writing whether paying the nonqualified credits due would have that effect. If not, they're paid by December 31. The bank's loan terms leave these payments out of its tests, so paying them doesn't put a co-op in default, and the federation pays for the finding.
• No five-year note. After a two-year pause, other paused payouts become a debt repaid over five years (Member Capital Accounts). Stretching nonqualified credits out that way would count as putting them off, which the rules allow only with a year's notice and at least five more years' wait (§ 1.409A-2(b)(1)). So they stay paused and are paid in full in the first year the co-op can pay them without that risk. That means they can be paid ahead of former members waiting on the note, an exception to the rule that the same year's credits are treated the same. They belong to the lowest-paid members, and are usually small.
• Small balances follow a rule set in advance. Paying a whole balance early is allowed if it's under a federal limit well above the $2,000 used here, pays out everything the co-op owes that person under every similar deferred arrangement, and the co-op's decision is in writing by the payment date (§ 1.409A-3(j)(4)(v)). So the plan counts all of a person's nonqualified credits together, and the board records the decision at each payout.
• If a co-op gets it wrong, it fixes it and pays the cost. It first uses the IRS's correction program, which cuts or removes the extra tax for mistakes fixed quickly (IRS Notice 2008-113). Whatever extra tax and interest remain, the co-op pays, grossed up for the tax on that payment. That payment is wages, so it goes through payroll, and it's paid by the end of the year after the member pays the tax (§ 1.409A-3(i)(1)(v)). It doesn't make up for public benefits a member loses when years of income land at once.

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). 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, and the model makes the same argument under state wage laws, though not every law sees it the same way (Owners Are Still Workers).

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

Many care and cleaning workers count on public programs, and becoming a member shouldn't cost anyone their benefits. The aim is for benefits agencies to count this money correctly, not to hide it from them. Programs look at two things: savings and income.

Savings

Some programs have a savings limit. For Supplemental Security Income (SSI), it's $2,000 for one person (20 CFR 416.1205), and Medicaid for older and disabled people generally uses similar rules. Medicaid for most working-age adults has no savings limit at all: "A State shall not apply any assets or resources test" (42 U.S.C. 1396a(e)(14)(C)).

The membership share and credits that haven't come due shouldn't count as savings, because members can't turn them into cash. SSI counts property a person "could convert to cash," and "if a property right cannot be liquidated, the property will not be considered a resource" (20 CFR 416.1201). Food assistance (SNAP) doesn't count "resources having a cash value which is not accessible to the household" either (7 CFR 273.8(e)(8)). That only holds if members really can't get at the money. So the standard bylaws say that the share and account credits can't be withdrawn early, sold, given away, pledged or borrowed against, except that they pass to a named person on death and a court can divide them in a divorce (Member Capital Accounts). The co-op gives members a statement of the facts for their caseworker: the balance, the payment dates and that clause.

Income

Profit shares count as income for Medicaid, marketplace health insurance subsidies, food assistance and housing aid. Four things make this harder than it looks.

SSI may count a credit when it's made, not when it's paid. SSI counts income "at the earliest of the following points: when you receive it or when it is credited to your account or set aside for your use" (20 CFR 416.1123; the same for wages in § 416.1111). A member under twice the poverty line can already choose to take their whole share in cash, so a credit they leave in the account could be seen as income they set aside. So members on SSI get their whole share in cash, with nothing credited to an account and nothing held back for the buy-in, until Social Security says how it counts credits. They're full members all the same.

SSI may count the share as the less favorable kind of income. Wages, including "bonuses... received because of your employment," are earned income (20 CFR 416.1110), and SSI ignores the first $65 a month and half of the rest (§ 416.1112). Dividends, "returns on capital investments," are unearned income (§ 416.1121), and SSI ignores much less of it. The model argues the share is an owner's share for tax purposes (Owners Are Still Workers), and Social Security may take it at its word. So every example shown to a member on SSI assumes the worse answer, and the same question matters for other rules for disabled workers, including the ones that let them keep Medicaid as they earn more. Opting out of membership doesn't change this, because workers who aren't members get a cash share too.

Timing helps some programs and hurts others. SNAP treats a one-time lump sum as savings, not income (7 CFR 273.9(c)(8)). SSI counts it as income in the month it arrives. So a payout from an account can come as one payment or up to 12 monthly payments, and which is better depends on the member's programs. The federation's benefits advice helps each member choose.

ABLE accounts protect savings, not income. A member with an ABLE account, a savings account for people whose disability began young, can have payouts paid into it. Balances up to $100,000 don't count against SSI's savings limit, but the money still counts as income in the month it's paid, and deposits are capped each year ($20,000 in 2026) (POMS SI 01130.740).

What the co-op and federation do

• A benefits check before anyone is signed up automatically. The federation, not the co-op, offers every worker on probation a confidential benefits check in their own language. The co-op doesn't ask anyone about disability or benefits. A worker the check shows is on SSI or disability benefits becomes a member only if they say yes.
• A statement at every credit and every payment, so members can report both to their agencies on time. Members are told they must report them.
• Getting an answer from Social Security. Social Security doesn't give advance rulings. The federation asks it in writing for guidance on how it counts profit shares and credits, and supports a real member's case through appeal if needed. It shares the answer with every co-op.
• Benefits advice for every member, along with the templates and training the federation already supplies (The Federation).

The model doesn't shrink the benefit cliffs themselves. A low-paid member on several programs at once can lose much of a profit share to lower benefits and higher rent. The advice can show them that before they decide. It can't change it.

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)). 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)), 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. 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)). 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.