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Energy Cooperatives

Rural Electric Cooperatives (RECs)

Rural electric cooperatives (RECs) are consumer-owned utilities that generate and distribute power to areas of typically low population density. Investor-owned utilities (IOUs) historically neglected to serve rural areas because of the substantial infrastructure investments it would require, and the relatively low economic returns on investment. In fact, by the 1930s nearly 90% of U.S. urban dwellers had electricity, but 90% of rural homes were without power. To this day, the nation’s approximately 900 RECs remain the primary energy provider to most of the country’s rural areas — serving 12% of the nation’s electric consumers, but owning and maintaining 42% of the nation’s electric distribution lines that cover 75% of the country’s land mass (National Rural Electric Cooperative Association).

Prior to RECs, those rural U.S. populations that could access electricity were forced to pay very high rates relative to the urban service areas of IOUs. Consumer cooperatives have not only created an economic mechanism for these areas to access electricity, they have enabled members to leverage their collective buying power and access electricity at wholesale prices, deliver directly to consumers, and provide reliable, low-cost energy.

Organizational Structure

The following information is from University of Wisconsin Center for Cooperatives:

Electric cooperatives are incorporated under state statutes. They are considered nonprofit corporations and are granted Federal tax-exempt status under IRC section 501(c)(12), provided that 85% or more of their annual income comes from members.

Each rural electric cooperative (REC) customer is a member-owner, and membership is a requirement of all customers. Since most RECs operate as monopolies, consumers must become cooperative members if they wish to purchase electricity. Members are required to purchase all of the electric power for a specified location from the cooperative. However, in some cases RECs will sell power to non-members. Members elect a board of directors from among the membership on a one-member/one-vote basis.

As with other cooperatives, RECs strive to operate at cost. However, like other businesses, RECs must accumulate equity capital to support their operations and new initiatives. Because the members are owners of the cooperative, when the REC has net earnings (i.e., revenues exceed expenses), or margins, those margins are returned to member-owners based on patronage.

Among the REC cooperatives, the amount of margin allocated to each member is called a “capital credit.” Capital credits are allocated to members’ accounts, but the underlying value is retained by the cooperative for a period of time. Most RECs have capital credit retirement programs, by which the cooperative gradually returns the value of past allocated capital credits to members. In most cases, members receive the value of their capital credits as a deduction on their electric bill.

Legal Structure

RECs are typically structured as 501(c)12 organizations, which requires that they be organized and operated as mutual or cooperative organizations. The following are select sections from the IRS rules for 501(c)12 organizations:

IRS Requirements for Cooperative Electric Companies

IRC 7.25.12.5  (08-09-2006) REQUIREMENTS FOR MUTUAL DITCH, IRRIGATION, COOPERATIVE TELEPHONE OR ELECTRIC COMPANIES, AND “LIKE ORGANIZATIONS”:

  1. Ditch and irrigation companies, telephone companies, electric companies, and “like organizations” that seek exemption under IRC 501(c)(12) must be organized and operated as mutual or cooperative organizations. The terms “mutual” and “cooperative” have no legal distinction for purposes of section 501(c)(12). The U.S. Tax Court defined “cooperative” as follows:
    “A cooperative is an organization established by individuals to provide themselves with goods and services or to produce and dispose of the products of their labor. The means of production and distribution are those owned in common and the earnings revert to the members, not on the basis of their investment in the enterprise, but in proportion to their patronage or personal participation in it.”
    Puget Sound Plywood, Inc. v. Commissioner , 44 T.C. 305 (1966), acq. 1966-2 C.B. 6.
  2. The court described the organizational and operational cooperative principles as follows:
    1. Democratic Control. The organization must periodically hold democratically conducted meetings with members. Election of officers must be on a one member, one vote basis. Meetings must have a quorum of members in attendance or voting by proxy.
    2. Operation at Cost. The organization must allocate all excess operating revenues (excess of revenue over expenses) among the members.
    3. Subordination of Capital. The organization must ensure that those who contribute capital neither control the operations nor receive most of the pecuniary benefits. The organization will meet this requirement by ensuring that the members control and own the savings or monetary benefits rather than the shareholders or equity investors.

The Service sets out additional organizational and operational cooperative requirements that an organization must meet for exemption under IRC 501(c)(12). Rev. Rul. 72-36, 1972-1 C.B. 151. These requirements are:

  1. The organization must keep adequate records of each member’s rights and interests in its assets.
  2. The organization must distribute any savings to members in proportion to the amount of business done with them based on the “operation at cost” principle.
  3. The organization must not retain more funds than it needs to meet current losses and expenses.
  4. The organization cannot forfeit a member’s right and interest in the organization upon termination of membership.
  5. Upon dissolution, the organization must distribute the gains from the sale of any appreciated assets to all persons who were members during the period that the organization owned the assets, in proportion to the amount of business done by the members during that period.

The 85-Percent Member Income Test

IRC 7.25.12.8  (08-09-2006): THE 85-PERCENT MEMBER INCOME TEST

  1. A cooperative exempt under IRC 501(c)(12) must receive 85 percent or more of its income from members. The 85-percent member income test requires that the income be
    • derived from members and
    • used to pay for services listed in IRC 501(c)(12)
      Rev. Rul. 2002-55, 2002-2 C.B. 529; see Rev. Rul. 2002-54, supra, Treas. Reg. 1.501(c)(12)-1(a), and Credit Rural Electric Cooperative Corp. v. Commissioner , supra.
  2. The 85-percent member income test is computed each tax year. If in any year the member income falls below 85 percent of the total income received that year, the organization is no longer exempt under IRC 501(c)(12) for that tax year and must file a corporate tax return. Rev. Rul. 65-99, 1965-1 C.B. 242.
  3. When an organization uses the accrual method of accounting, it will use the same method to compute the 85-percent member income test. Rev. Rul. 68-18, 1968-1 C.B. 271.
  4. Electric cooperatives do not have to subtract the cost of goods sold from gross sales to calculate the 85-percent member income test. Prior to 1998, the Service’s position was that an electric cooperative must deduct the cost of goods sold for purposes of calculating the 85-percent member income test. See Rev. Rul. 80-86, 1980-1 C.B. 118. This position was proposed for formal adoption in Prop. Treas. Reg. 1.501(c)(12)-2 (49 Fed. Reg. 1244, 1984). The proposed regulation was withdrawn. See 58 Fed. Reg. 25587 (April 27, 1993). Under the safe harbor guidelines, electric cooperatives may continue to use the method they have consistently used in the past. Ann. 96-24, 1996 I.R.B. 35, (12)22.3(b).
  5. A benevolent life insurance company is not entitled to exemption if it issues policies for stipulated cash premiums, or requires advance deposits to cover the cost of the insurance and maintains investments from which it gets more than 15 percent of its income. However, if an organization makes advance assessments for the sole purpose of meeting future losses and expenses, and retains the balance of the assessments remaining at the end of the year to meet losses and expenses or returns it to members, it may be entitled to exemption. Treas. Reg. 1.501(c)(12)-1(a). The Court of Claims has held that:
    “…[T]he income of the association did not consist solely of assessments, dues, and fees collected from members. It had income from large investments in certificates of deposits and United States bonds, and this income, as stated, was deposited and commingled with the general fund of the association in the bank and used for paying expenses. It was income derived from investments. Certainly there is at least a grave doubt as to whether the plaintiffs come within the exemption, and it must be held that they are not entitled to be exempted.”
    Hardware Underwriters v. United States , supra.

Read all requirements for IRS rules for 501(c)12 organizations.

Government Programs and Financial Support

The following information is from University of Wisconsin Center for Cooperatives:

Since the Federal government’s early commitment to cooperative ownership during the New Deal, rural electric cooperatives have had strong government support through lending programs, and through power supply preference programs. REA loans and technical assistance provided the primary momentum for rural electric cooperative formation. Over time, however, the dominance of Federal lending has declined. Currently, RUS loans to electric cooperatives comprise <40% of total financing; >60% comes from private sector sources such as the CFC and the National Cooperative Services Corporation (NCSC). Nonetheless, RUS financing remains an essential component of the cooperative utility sector’s loan portfolio.

Further government lending supports rural electric cooperatives’ economic and community development programs. USDA’s Rural Economic Development Loan and Grant (REDLG) program provides zero-interest loans and grants through electric cooperatives to work in partnership with business and community leaders.

Electric cooperatives, as well as public utilities, have received preference from the Federal power marketing agencies since the first cooperative was established in 1937. The agencies market excess power generated by Federal water projects, and five power marketing agencies currently operate within the U.S. Department of Energy. The government support provided through the “preference clause in power supply” has been critical to ensuring cooperative access to sources of power.

Although governmental support was critical to the formation of consumer-owned electric cooperatives, all electric utilities receive various federal subsidies. In fact, according to calculations based on Federal government financial reports, rural electric cooperatives receive the smallest Federal subsidy per consumer (NRECA) As with other utilities, government support to electric cooperatives has been provided through loan programs or policy involvement rather than direct subsidies.

For more information, see the USDA’s Rural Development Energy Programs and Notices of Funding Availability.

Sample REC Bylaws

Sample Documents and Policies

Member Handbooks

Peace River Electric Cooperative (Florida)

Firelands Electric Cooperative (Ohio)

Grayson-Collin Electric Cooperative, Inc. (Texas)

Central Electric Cooperative

Employee Handbooks

East River Electric Power Cooperative  (South Dakota)

Other Resources on RECs

Material on this page was compiled by SELC City Policies Program Director, Yassi Eskandari, and by Jill Jacobs, an attorney, SELC volunteer, and Sustainable Economies Law Fellow.

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