TAX FORM 1120C, SCHEDULE G

With the change in the 80/20 rule, New York City co-ops boards could very well be nervous and confused because of a new spin on what has been a benign problem until now: how to account for non-patronage income.

"Patronage" income, which is that derived from co-op members, includes funds paid by these "patrons" as well as building services that can be used by the group. Whether it's a garage or dry cleaner, as long as it's proven to be a viable business for co-op members, it has gotten the same tax break as standard patronage income.

Theoretically, commercial income — derived from such "non-patronage" sources as a grocery store or real estate office independent of the group — is could have been taxed at a higher rate. However, by most accounts, the average co-op has been operating on a break-even model.

Now the Internal Revenue Service (IRS) has cracked down with a new form, 1120C, and its accompanying Schedule G, as a replacement for Form 1120, thereby obliging co-ops to clearly delineate income derived from these non-patronage sources.

A key factor in determining whether interest income is patronage income has to do with its relevance to the co-op's overall operations. "You need to show the relationship the interest has to operating your business. If you can show it was set aside to pay next month's bills, next month's capital improvements, then you have a pretty good argument that it's patronage," says accountant Robert Mellina, a partner with Zeidman, Lackowitz, Prisand & Co.

Thank You for Your Non-Patronage

While CPAs are advising clients to consult their accountants and start drawing a clear delineation between patronage and non-patronage income, the new form won't carry much weight for most co-ops in the city since most don't have significant commercial space allocations.

Even so, all co-ops need to figure out how much of this will affect them, and to get their books in order. "I got an emergency phone call from my accountant saying this is an issue we had to deal with," recalls Adelaide Polsinelli, board president of the 350-unit 2 Fifth Avenue. "Of course, we had no idea what he was talking about. We all heard this 80/20 rule was going to be changed. [But] what we learned was that what the government giveth with one hand, they taketh away with the other."

Peter Spiess, a director of the international accountancy firm PKF, stresses that when differentiating patronage from non-patronage income, the chief determinant is the income's relationship to the main purpose of the cooperative, its "principal business activity." Most co-ops have taken the position that all income is effectively patronage-sourced, but with the new form "the IRS may have taken the first step to challenging this position."

So how will co-ops honestly account for what's what? Determining patronage from non-patronage varies on a case-by-case basis and is all "fact-driven," notes Abe Kleiman, partner at Kleiman & Weinshank, adding, "You may have one co-op that has the dry-cleaning store and you can make the argument that it's an amenity to the shareholder. It would be as if the co-op said, ‘We are renting the space out to a dry-cleaning store at below-market rent because we want to have the amenity there.' So, you can make the argument it's for patronage. But if you are smack dab in the middle of Manhattan and there are five other dry-cleaners nearby [you might not have a claim]."

PKF, in a memo to its clients, offers some examples of patronage income:

• Maintenance charges and special assessments

• Interest income on funds held to advance the co-op's purposes

• Sublet fees, late charges, flip taxes, storage charges, laundry income and the like

• Garage parking if its main purpose is to serve tenant-shareholders, subtenants or guests.

In some cases, though, determining patronage income isn't clear-cut. Queens real-estate attorney Joel E. Miller says that if, for example, a business such as a dry-cleaners is in a building that's in the middle of nowhere, it's patronage income. But the problems can arise at other time — specifically when a co-op moves into a building that already has shops included.

While the new form won't have tremendous effect on an estimated 90 percent of co-ops without significant commercial space, the impact of the change is still being weighed. Many professionals agree that it is one of the more confusing alterations in IRS code in some time and that all co-ops need to run it by their CPAs.

— Laurie Wiegler

Adapted from Habitat April 2008. For the complete article and more, join our Archive >>