Cooperative v. LLC – Considerations in Form of Organization

Previously published at Northwest Citizen

This article addresses some decision factors in entity formation which are not frequently considered, especially for groups whose main motivations are civic rather than pecuniary. Where the key objective is limited liability for members of the group, the choice of entity is based more on qualitative factors as many different entities convey this limitation on liability, either not-for-profit, or for profit entities. And either form of entity can support ancillary business – from a State tax Business and Occupancy perspective, a not-for-profit cooperative and an LLC’s business operations are treated the same. I hope this discussion can help groups in their deliberations on entity formation.

People form and join organizations with a civic or other higher purpose than profit for many and various reasons – civic, religious, fellowship, etc. This is in contrast to the corporate forms of organization where profit is the sole objective. However, whatever the organization’s purpose, it is sensible to document a charter which makes explicit the rules of governance, and most importantly, to incorporate a formal limited liability entity to protect its members/shareholders from personal liability for the organization’s or other members’ tortious acts. Incorporation also creates a person in law that is able to contract, hold a bank account, and transact business in its own name.

There are many forms of limited liability organization permitted in law, and these are evolving. They are generally divided into for-profit forms: LLC and LLP; and not-for profit forms: membership organizations, cooperatives, and general not-for-profit incorporations. (for the purpose of this article, I have not considered S or C corporations as options as they represent corporate forms of organization more suited for purely business ventures).

LLC’s: In my early career, CPA’s and lawyers were not permitted to incorporate – firms were partnerships where every partner was jointly and severally liable for the tortious acts of their partners. Which is why being invited into the partnership was a double-edged sword as the new partner shared in the profits but also in the risk! In a litigious society, a pure partnership is not practical – and so limited liability partnerships were legally created – LLP’s for professional partnerships; LLC’s for other partnerships. These are “flow-through” organizations for income tax purposes – they attract no tax liability as the taxable income flows through to and is taxed in the hands of the individual partners.

Cooperatives: There are also several forms of limited liability incorporation available for not-for-profit organizations in Washington State. Among these are membership organizations, including clubs and social organizations and also convents and monasteries, and cooperatives. Incorporation confers limited liability on members, and the ability to contract, as in LLC forms. As well, an incorporated not-for-profit attracts no income tax except under abusive situations. The charter of a not-for-profit is flexible, reflecting the gamut of causes, activities, and purposes for which not-for-profits are incorporated.

The key in both forms, LLC and Cooperative, is the general rules under which it is governed: the operating agreement, in the case of an
LLC, and the charter and bylaws, in the case of a cooperative. The specific entity chosen is far less important than its partners/members, and how they decide to run the show. SO what are the distinctions between LLC’s and Cooperatives?

1) General: the biggest difference is that an LLC has partners who are also owners, and a cooperative has a board of directors and no
ownership – effectively, all not-for-profits are “owned” by the State.

2) Business and Occupancy tax: It’s expected that an LLC will run a business; a cooperative may also run a business under its bylaws. Both operate similarly for the purpose of Business and Occupancy Taxes: State and local business and occupancy taxes are payable based on sales for either organization.

3) Income tax – as noted above, an LLC attracts no income tax – all profits flow through to the partners who pay personal income taxes on their share. A cooperative has more flexibility – profits may be retained in the cooperative without attracting income tax – and dividends paid out to members, who then pay personal income tax on the dividend income. This may confer an advantage on cooperatives, as capital may be maintained in the cooperative untaxed, unlike LLC’s where all net income is taxed.

4) Reporting and compliance loads are similar for both LLC’s and cooperatives, at a State level. However, an LLC is obliged to file federal tax information, which a cooperative is not obliged to do unless it pays out dividends. In general, a State-incorporated cooperative has no federal filing requirements, unless it chooses to register federally as a 501c3, which it is required to do if it wants to issue tax-deductible donation receipts.

5) Banking – both forms can have bank accounts – based on a Board-passed bank resolution. One small advantage of a cooperative is that many financial institutions offer a zero-fee checking account for cooperatives and other not-for-profits, including, for example, WECU and Peoples’ Bank locally.

In sum there is a small administrative cost advantage to a cooperative, and an additional potential advantage where there is net income.
The main considerations in a choice between the two, however, are subjective.

1) Volunteers: if the organization will rely on volunteers to accomplish its ends, it seems to me that people are far more likely to volunteer for an organization that is devoted to a cause and not for profit. An LLC by definition is for profit. How many LLC’s have a substantial volunteer base? Clearly most not-for-profits do have volunteers.

2) Donations: again, if the organization solicits donations, people are more likely to donate to a not-for-profit than to a for profit
organization.

3) Ownership: Offsetting the above is that not-for-profits have no owners – they are governed by a board, elected by members. I’ve seen it happen that the founders of a successful not-for-profit, having labored mightily to get the thing going, lose control of the organization to other members taking over the Board. In an LLC, each partner has an ownership interest with rights and although they may lose control over the Board, they maintain their ownership interest in the profits of the LLC.

But this bears repeating – whatever form of incorporation is chosen, any organization needs general cooperation between its members, a set of bylaws which lay out purposes and specific governance rules, and finally, something I have not yet mentioned as it in itself justifies an article – internal controls over money need to be tight to protect members and officers from misappropriation and/or misuse of funds.

Finally, in the monopoly capitalist model that controls our economic life, LLC’s and cooperatives provide a mechanism for localization in
the face of increasing concentration of wealth on a global scale. Globalization destroys local economies and societies – it takes effort to counter its deleterious effects.

Prepared as a Public Service by David M. Camp, cpa WA Licence # 30879

This article is copyright by the author under Creative Commons Licence CC BY 3.0 – Share with attribution

Leave a Reply

Your email address will not be published. Required fields are marked *