Ownership Has Its Privileges...First Pioneer's 2006 Patronage Distributions
Overview of 2006 Patronage Events
- February ¾ $20 million qualified patronage distribution to eligible 2005 customers, including checks totaling $12.0 million and notices of Allocated Retained Equity (ARE) totaling $8.0 million. This distribution accounts for $20 million of First Pioneer’s earnings for the 2005 operating year. The total distribution, cash plus ARE is taxable to you on your 2006 tax return.
- Later in February ¾ Non-qualified distribution of equity to eligible 2005 customers. This represents the remainder of 2005 earnings that were not distributed in the qualified patronage distribution, but were retained as capital to support First Pioneer’s ability to obtain loan cost funds. You owe no tax on this distribution at this time. Please see below for details on this new type of equity distribution from First Pioneer.
- May ¾ $7.4 million of ARE that was distributed in February 2001 will be redeemed and distributed to its customer-owners. This was earned on eligible customers’ patronage in 2000. This redemption is subject to an affirmative vote by First Pioneer’s Board of Directors at its March meeting. You owe no tax on this redemption – you already paid the tax, if any, for this distribution on your 2001 return.
Your Ownership of First Pioneer Farm Credit, ACA
First Pioneer is a financial cooperative chartered under the Farm Credit Act of 1971 as amended. Eligible customers (“members”) own and control First Pioneer, in a parallel manner as shareholders own and control a public company. Eligible customers own First Pioneer in three different ways:
- Through $1,000 of stock that they purchased at the time they took out a loan.
- Through Allocated Retained Equity (ARE) that was paid as patronage over the past five years and which is still in First Pioneer’s capital account. While it is First Pioneer’s plan to employ this capital for 5 years and then redeem it, this is always subject to a vote by the Board of Directors.
- Through Unallocated Retained Equity (URE) held in First Pioneer’s capital account. This is the sum total of First Pioneer’s past earnings that were not distributed as patronage, but held in order to properly capitalize the cooperative. Starting this year, First Pioneer will earmark each eligible customer’s share of URE that was added to its capital account from the past year’s earnings through the Non-Qualified Allocation process described in the next section.
Non-Qualified Allocations
Starting now for the prior year’s retained earnings, First Pioneer will earmark each eligible customer’s share of unallocated retained earnings as non-qualified allocations. (This is IRS terminology that describes this nontaxable event.) This is permanent capital necessary to First Pioneer’s successful operation as a going financial cooperative for the foreseeable future. There is no plan to redeem it in cash and you should regard it as a permanent investment in the cooperative. It would only be taxable to you if, for some reason, your Board of Directors approves a cash redemption of a Non-Qualified Allocation in the future.
Your Board’s reason for doing this is to protect your rights in the future in the event of unforeseen circumstances. This has occurred with other cooperatives in the past and the URE portion of capital becomes a major financial problem. Your Board and Management feel that it is just prudent financial practice to start assigning ownership of this portion of the co-op’s equity going forward.
You will receive a notice as to your share of this non-qualified distribution under separate cover sometime after the regular qualified distribution is made.
Why Capital?
A financial institution relies on its capital (net worth) for its ability to attract competitively priced funds and to assure its regulator that it is operating “safely and soundly.” This is equally true whether it is owned as a cooperative or as public stock company. In the case of a cooperative, the customer-stockholders invest and own this capital. First Pioneer’s sound level of capitalization enables the following:
- The ability to borrow loanable funds for its customers at among the very best rates in the market. These savings are passed on to customers as very competitive interest rates.
- For First Pioneer’s Board and Management to make the decision to keep lending to farm industries and individual borrowers who are under economic stress far longer that would otherwise be permitted by our regulator, the Farm Credit Administration.
- Your control of the cooperative as customer-owners who control the Board of Directors through elections and appointments.
First
Pioneer Patronage History ¾1995
through May 2006 |
|
| First Patronage Distribution | 1995 |
| First ARE Redeemed |
2002 |
| Total Patronage Distributed to Date | $136 million |
| Total Cash to Customers to Date | $102 million |
| Total ARE Equity Held by First Pioneer Customers | $34 million |
Questions and Answers
About First Pioneer’s
Patronage Dividend Program
Question #1 Who are First Pioneer’s stockholders?
Answer #1
A farmer, fishermen, or forestry producer who obtains a loan from First Pioneer is required to purchase $1,000 of stock and to retain that stock investment on the books as long as they have a lending relationship with First Pioneer. This stock is not transferable and it is not tradable. Because of its cooperative structure, First Pioneer has no other stockholders.Question #2 Why is a borrower required to purchase stock?
Answer #2
The simple answer is that the charter under which First Pioneer operates requires this without exception for the types of borrowers mentioned. A better answer is that this borrower ownership is what fundamentally makes First Pioneer a financial cooperative rather than a publicly owned stock financial cooperation.Question #3 What is a patronage dividend?
Answer #3
A patronage dividend is to a cooperative as a stock dividend is to a corporation – a mechanism for distributing the company’s profits to the company’s owners over the normal course of doing business. There are, however, two unique features to a patronage dividend that specifically reflect cooperative ownership:- Dividends are paid in proportion to the customer-owner’s "patronage" during the past year, i.e., the amount of interest that a First Pioneer customer accrued on their loans.
- Patronage dividends are taxed just once, at the member level. This means that the cooperative has the opportunity to be “tax efficient” by paying earnings out to members and letting them pay tax at their marginal tax rate which is usually less than the corporate rate that the cooperative would pay on them. Most corporate earnings are taxed twice: first at the corporate level (before dividends are paid out), and second at the stockholder level.
Question #4 How come I do not receive cash for the entire amount of the patronage dividend?
Answer #4
Your First Pioneer dividend consists of a cash portion and an Allocated Retained Equity (ARE) portion. You receive the cash portion as either a check or an ACH credit into your checking account. The ARE portion is retained as member capital under your name in First Pioneer and is accordingly not paid out at this time. The ARE portion will be redeemed at some future time by the Board of Directors when, in their judgment, First Pioneer has the financial capacity to do so. Past practice and the current financial plan is to hold ARE for five years and then redeem it; but again, this is always at the discretion of the Board.Question #5 When do I report the patronage dividend as taxable income?
Answer #5
Your patronage dividend, both the cash and ARE portions, should be reported as income on your tax return for the year in which you received the patronage. You will receive a letter informing you of this at the time of the distribution and then an IRS Form 1099PATR in the January following the distribution. So for a patronage dividend that you receive in February 2006, you will receive a 1099PATR in January 2007 and you should report the entire amount on your 2006 tax returns filed in early 2007. Make sure to provide the 1099PATR to your First Pioneer tax specialist or other tax professional at the time you provide your other tax information.Question #6 Do I owe additional tax when the ARE is redeemed in a future year?
Answer #6
No. You have already paid the tax on the ARE portion in the tax year in which you received it and no further tax is due when you receive the cash. It is considered a return of equity at that point by IRS and your state taxing authority.Question #7 If I pay my loan off in full, can I receive my ARE back at that point?
Answer #7
No. All owners of a particular pool of ARE will be cashed out at the same date as determined by the Board of Directors. If you pay off all your loans, it is important that you maintain a current address with First Pioneer until all of your ARE is redeemed.Question #8 What is a “non-qualified allocation” (NQA)?
Answer #8 Starting in 2006, eligible customer-stockholders will be notified of a non-qualified allocation of equity which represents the remainder of First Pioneer’s earnings for the prior year which were not distributed as patronage dividends. First Pioneer’s Board has determined that this is a prudent practice to protect both today’s members and the cooperative in the event of some unforeseen future event impacting on First Pioneer’s capitalization and/or ownership structure. While not required for either regulatory or taxation purposes, your Board believes this to be a cooperative best practice.
Question #9 Do I owe tax on the non-qualified allocation?
Answer #9 No. This is a nontaxable event to the customer-stockholder receiving the NQA. You will not receive a 1099PATR and you do not need to report this to IRS or your state taxing authority.
Question #10 Will this NQA be cashed out at some future time?
Answer #10 This is First Pioneer’s “permanent capital” and it is not contemplated that this capital would ever be paid out to members. You should not count this capital on your financial statement and you should not expect that it will ever be cashed out. The process of allocating it in this way is a prudent measure now in the event of some extraordinary event down the road.
Question #11 As a borrower, how do I benefit from patronage dividends?
Answer #11 First Pioneer charges a rate of interest that is competitive with what other lenders would charge you. It endeavors to operate in an efficient manner that enables it to be profitable while being competitively priced to other lenders. These profits are then used to capitalize the cooperative and to pay patronage dividends to customer-owners. Your patronage dividend reduces your effective cost of borrowing from First Pioneer.
Question #12 How much can I expect to earn in patronage dividends?
Answer #12 Patronage dividends can vary based on the profitability of First Pioneer, its need for capital, and the decision of the Board of Directors each year. Since inception of this program, the average patronage distribution has been around 1% of average member loan balance.
Question #13 What if I have other questions about my cooperative and the patronage dividend program?
Answer #13
Please ask your First Pioneer representative. Or, you can email us at
info@firstpioneer.com
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