What Are Capital Credits

Have you ever wondered what those strange “capital credit” notices are that you receive from your electric cooperative? If so, you’re not alone! Many cooperative members scratch their heads when they see mentions of margins, allocations, and retirements on their statements.

In this comprehensive guide, we’ll demystify capital credits and explain exactly how they work. Whether you’re a long-time co-op member or just signed up for service, you’ll learn what capital credits represent, how your co-op uses them, and when you can expect to see that money again.

Grab a cup of coffee and get ready for a crash course on one of the best benefits of being a co-op member-owner!

What Are Capital Credits and How Do They Work?

Capital credits represent your ownership stake in the electric cooperative you get service from. As a member, you help fund the co-op’s operations and infrastructure. The revenues left over after covering operating expenses each year are called “margins,” similar to profits at a regular company.

Instead of keeping the margins, your co-op allocates them to members annually as capital credits based on how much electricity you purchased. For every dollar you paid in bills, you get back a proportional share of the margins.

So capital credits are essentially your equity in the co-op. Rather than taking the margins as profits, the co-op retains them as operating capital. This member-furnished equity allows the co-op to invest in reliability improvements, maintenance projects, and minimize borrowing. It’s one reason why cooperatives can provide affordable rates!

The allocated capital credits are eventually returned to you, but on a planned schedule rather than all at once. When the co-op retires capital credits, it’s essentially paying you a refund on your ownership stake, similar to an investor-owned utility paying shareholders dividends.

Key Differences Between Capital Credits and Dividends

Although capital credit retirements function somewhat like shareholder dividends, there are some important distinctions:

Cooperatives are non-profits owned by members, whereas investor-owned utilities are for-profit companies owned by shareholders.
Capital credits represent a return of your ownership stake rather than return on an investment. The allocation is tied to your usage and payments.
The board determines when capital credits are retired based on the co-op’s financial needs. Dividend schedules are usually consistent.
You can receive capital credits even if you pay a small monthly bill. With stocks, dividends depend on the number of shares owned.

So in summary, capital credits give everyday members a stake in their non-profit co-op when margins are allocated. The retirements simply return those funds after a period of retaining them as operating capital.

Capital Credit Allocation Process

Now that you know what capital credits represent, let’s look at how the allocation process works:

At the end of each fiscal year, the co-op calculates total margins for that year. This is total revenue minus operating costs.
They determine the allocation factor by dividing the total margins by total revenue collected from members that year.
Your specific capital credit allocation is found by taking your total payments for electricity that year and multiplying it by the allocation factor.
You’ll receive an annual notice showing your capital credit allocation for the prior year. The notice explains the amount allocated to your capital accounts.
The allocation can’t be used to pay your current electric bills. It is invested in the cooperative until future retirements.
An allocation remains tied to you even if you move, so that you can receive future retirements.
If both spouses are members, the allocation may be split evenly between them.

So in a nutshell, capital credits represent your slice of the “co-op pie” based on your electricity purchases for that year. The process annually credits you your fair share of ownership.

Use of Allocated Capital Credits

You might be wondering why the co-op doesn’t refund your slice of the pie right away. Great question!

The reason cooperatives retain allocated capital credits for a number of years is to use them as operating capital. By aggregating members’ allocations, the co-op creates a substantial source of equity.

This equity allows them to:

Minimize borrowing and avoid unnecessary interest costs that could increase rates.
Maintain financial ratios required by lenders and regulators. Capital credits are considered member equity.
Invest in reliability improvements, new equipment, system maintenance and storm repairs that benefit all members. These are long-term capital investments.
Stabilize rates through years with lower margins to prevent frequent rate hikes.
Withstand emergencies, natural disasters, or unforeseen costs.

Capital credits provide cooperatives with financial flexibility and stability without needing to raise rates or incur more debt. They form a substantial part of the equity cooperatives rely on.

Capital Credit Retirement and Refunds

So when do members finally get refunded their allocated capital credits?

Every year, the cooperative’s board of directors determines if financial conditions permit retiring and refunding capital credits to members. The goal is typically to rotate and retire allocations on a long-term schedule such as 20 years.

During each retirement, the co-op will refund the oldest allocations first, then work its way forward. For example, they may retire all allocations from the years 2000-2002 to members currently on record.

When capital credits are retired and refunded, members will generally receive the payment as:

A check mailed to the address on file if the amount is over a certain minimum, say $25.
A bill credit on their account if still an active co-op member.
A payment held until the total exceeds the minimum payout amount.
Special retirements as approved by the board, i.e. estates.

Unclaimed capital credit retirements will be retained as liabilities until the member or estate is located. The co-op makes an ongoing effort to find previous members who are owed retirements.

Taxation of Capital Credits

Taxes aren’t due when capital credits are allocated to your account annually. At that point, they are still being used as operating capital by the co-op.

However, when capital credits are retired and refunded to you in cash or bill credits, the payment may count as taxable income. Whether or not retired capital credits are taxable depends on how electricity bill deductions were handled in prior years. Check with your tax advisor about your specific situation.

What Happens When Members Leave?

If you move or otherwise leave the electric cooperative’s service territory, your capital credit allocations don’t disappear. They remain on record in your name.

That way, when the board approves a retirement, the co-op can track you down to return your share of the equity. Make sure your contact information stays current so future retirements reach you.

For joint memberships, if the primary member passes away, future capital credit retirements would go to the surviving member. Upon the death of the final joint member, the estate can request to have all allocated capital credits retired early.

Special Cases

Beyond typical retirements, there are some special cases where capital credits can be retired early or transferred:

Estates – As mentioned, when the last surviving member dies, unretired capital credits can be paid out early to heirs or the member’s estate upon request.
Businesses – If a business member closes, dissolves, or incorporates, the business can decide to have future retirements paid to owners or assign the credits.
Organizations – When an organization like a church or school dissolves, the board will retire all allocated capital credits.
Co-op Acquisition – If the cooperative merges or is acquired, members typically receive an early payout of capital credits.
Financial hardship – Some co-ops may allow early partial retirements in cases of financial emergency.

So even major life events don’t cause allocated capital credits to vanish. The amounts stay linked to you until retirement.

In closing, capital credits are a unique benefit of being a member of an electric cooperative. While the process seems complex, it represents your ownership in a non-profit utility.

The credits allocated annually to your account reflect your equity stake. Although retained initially as operating capital, eventually those funds are returned to you through retirements.

Hopefully this guide covered all you need to know about capital credits in an engaging way. You now have the scoop on one of the best member benefits that cooperatives provide. Welcome to the club!