How US Social Cooperative Laws Could Accelerate Co-op Development

The US worker cooperative movement is surging. According to the 2021 Worker Cooperative State of the Sector report, there were 612 worker co-ops in the United States and hundreds more startups underway. Less noticed is that nonprofits have helped to make much of this rapid growth possible.

Following the Great Recession, innovative nonprofits have increasingly stepped up to incubate worker cooperatives in marginalized communities by providing organizing assistance, winning funding, and dedicating staff and resources to launching and sustaining worker cooperatives in their early stages.

In light of these developments, this article explores the role of US nonprofit incubators of worker cooperatives and argues that many of these co-op incubation projects resemble the global model of “social cooperatives”—cooperatives organized explicitly to provide services and economic opportunities to disadvantaged populations, and which often are allowed preferential tax rates.

Although the social cooperative model is not legally recognized in the United States, nonprofit co-op incubators have already laid the foundation for establishing such a model, which could be treated under tax law similarly to a tax-exempt 501c3 nonprofit. 

The Rise of Nonprofit Worker Cooperative Incubation

Since the 2000s, many cooperative development organizations have recognized a need to do more than provide limited technical assistance and co-op education. Some innovative co-op incubators have expanded co-op support services, including direct organizing, staffing, funding, and launching cooperative businesses among marginalized communities.

• The ICA Group

Founded in 1977, the ICA Group has helped launch childcare co-ops in five states, 14 homecare cooperatives in nine states, and alternative staffing agencies in 22 states in recent years.

• Prospera (formerly Women’s Action to Gain Economic Security, or WAGES)

Between 1996 and 2010, Prospera created six professional cleaning co-ops for low-income women from Central and Latin America.

• The Center for Family Life in Sunset Park (CFL)

Since 2006, the Center for Family Life has created more than 21 cooperatives for low-income residents, providing extensive co-op education and raising start-up capital to launch each cooperative.¹

• Rocky Mountain Employee Ownership Center (RMEOC)

RMEOC is a recent example of how an employee ownership center has grown to support a broader range of co-op incubation services. For example, RMEOC has led in organizing workers, raising capital, shaping public policy, and launching Drivers Cooperative–Colorado, a driver-owned alternative to Uber or Lyft.

By incubating cooperatives, some nonprofit organizations have set ambitious goals to scale up the cooperative movement.

• Co-op Cincy

Founded in 2011, Co-op Cincy has incubated several co-ops, including two union worker co-ops: Our Harvest (UFCW) and Sustainergy (USW). All told, a dozen co-ops in the network are operational in 2024.

The Roles of Nonprofit in Worker Co-op Incubation

One way that a nonprofit can help incubate a cooperative is by raising start-up capital. For instance, RMEOC expects to provide funding support for three years to Drivers Cooperative–Colorado. Throughout business planning and the prelaunch period, RMEOC has written grants and raised several hundred thousand dollars.

By incubating cooperatives, some nonprofit organizations have set ambitious goals to scale up the cooperative movement by creating social franchising cooperatives, which are defined as “an adaptation of commercial franchising in which the developer of a successful social concept (franchisor) enables others (franchisees) to replicate the model using a proven system and a brand name to achieve a social benefit.”² Social franchising enterprises are more common in Europe (such as in the UK, Germany, and Belgium) with “over 60 social franchises in Europe employing at least 10,000 people.”

There has been growing interest in social franchising in the United States, too. For instance, a well-established social franchising model is New York’s VisionSpring. Founded in 2001, VisionSpring sells almost 150,000 pairs of glasses annually in nine countries through five different social franchise cooperatives.³ Many groups named above—such as ICA Group, the Center for Family Life, and Prospera—have also led efforts to create social franchising cooperatives.

The ICA Group, for example, is already developing a peer network of cooperatives in the homecare sector and has expanded to over 29 states. In the case of platform cooperatives such as the Drivers Cooperative and Brightly, the need to scale up the movement via social franchising cooperatives has become a natural part of the long-term vision.

Marketing support is another crucial nonprofit incubator service. In the case of Prospera, their cleaning cooperatives were heavily advertised in the community through the nonprofit’s marketing expertise and public support networks. In the case of the Drivers Cooperative–Colorado, RMEOC has utilized its broad network of supporters to promote the co-op. To create a national federation of Drivers Cooperatives, different cities could similarly work with local nonprofits to utilize their marketing expertise and existing public networks to supercharge public awareness of the co-op from the outset.

Obstacles to Incubating Cooperatives

A significant challenge for nonprofits seeking to support co-op incubation is avoiding the nonprofit becoming improperly engaged with traditional (profit-seeking) business activity, thus jeopardizing the nonprofit’s tax-exempt status. Key questions revolve around whether nonprofit incubation of a profit-seeking social cooperative might conflict with nonprofit legal requirements.

Nonprofits are defined as groups that “are organized and operated exclusively for charitable, educational, and similar purposes.”⁴ Nonprofits must be dedicated to a positive social purpose (such as advancing the interests of low-income populations) rather than to securing profits for owners or investors. Nonprofits can earn surplus revenue, but this revenue must support future organizational activities, and the nonprofit “cannot distribute profits to investors as dividends.”

A nonprofit that incubates an income-earning co-op must carefully track and defend all “ordinary and necessary” business expenses to avoid tax problems.

These rules can challenge nonprofits that wish to work as co-op incubation organizations. The first nonprofit principle—the “social purpose” rule—is not such a demanding challenge, as most nonprofits would only seek to build worker cooperatives that employ and develop the economic prospects of traditionally low-income or otherwise marginalized populations, thus meeting the “charitable and educational purpose”⁵ requirement of nonprofit activity. In reviewing nonprofit activity for adherence to the tax code, the IRS will check if the nonprofit’s assistance is targeted to “benefit a ‘charitable class,’ such as minorities, the unemployed or underemployed, or other disadvantaged groups.” Meeting this expectation should not present much of a challenge to most nonprofit-incubated worker cooperatives.

Can Nonprofits Earn Business Income?

Beyond the “social purpose” rule, a second key requirement of nonprofits under US law is that nonprofit earnings cannot “inure to the benefit of any private shareholder or individual.” In other words, no person can profit or earn investment income from nonprofit activities.

But worker cooperatives are business endeavors, which seek to build the wealth and economic prospects of their individual members by earning profits. So, how can a nonprofit play a key role in incubating and even hosting a worker cooperative without violating US tax law?

One solution to this challenge begins with the understanding that nonprofits cannot pay investment dividends to individuals, but they certainly can pay wages and benefits to their staff (which could include members of an incubated worker co-op). Thus, a nonprofit could incubate and host a cooperative and foster a climate of good wages and benefits for all workers at that cooperative without running afoul of tax law—but that worker cooperative would not be allowed to distribute any net earnings to workers as ownership dividends.

Although true in theory, tax implications in practice can be more complex. A nonprofit that incubates an income-earning co-op must carefully track and defend all “ordinary and necessary” business expenses to avoid tax problems.

Often, co-op expenses are considered “unrelated business income” (UBI) for the nonprofit, and the IRS carefully examines the nature and extent of this UBI in evaluating an organization’s continuing status as a nonprofit (and thus tax-exempt). Although nonprofit cooperative support organizations can pay for co-op business expenses out of this UBI, there is an open question as to how much UBI a nonprofit can regularly earn and still maintain its nonprofit status. IRS rules do not clearly answer this question. The Sustainable Economies Law Center advises keeping UBI below 10 percent of total nonprofit revenues to be safe but encourages organizations to consult with tax or nonprofit attorneys.

The Need for a New Legal Regime

To avoid these legal complexities, a new legal regime governing US social cooperatives is needed. Although support for co-ops is growing, the support of nonprofit incubators will be necessary to maximize the success of co-op startups.

Unfortunately, unclear tax laws and thin US experience in aligning nonprofit “charitable” work with income-earning business enterprises have limited the potential success of the nonprofit/co-op alliance. To address this challenge, it is now a promising moment to develop legal recognition of a new organization form—the social cooperative—which can unite the strengths of nonprofit organizations and cooperative businesses to jointly mobilize to address enduring social problems.⁶

The most important characteristic of “social cooperatives” lies in their commitment to serve the “public interest” as their main purpose, meaning that “every good and/or service they produce should [serve] the public interest first,” such as by providing jobs or services to marginalized communities.

Thus, a worker-owned social cooperative that provides service in care sectors (such as childcare, homecare, elderly care, or care for the disabled) must go beyond the goal of making profits for members and must prioritize providing services to generally underserved sectors of the population (that is, the low-income elderly) and/or employing low-income, marginalized members of the population (that is, the formerly incarcerated).

This public interest goal is well aligned with a foundational co-op principle—“concern for others”—but whereas traditional cooperatives may prioritize earning income and profits for co-op members, a social cooperative must prioritize public benefit, even above seeking advantage for their cooperative owners.

Creating a “social cooperative” category in US law would allow nonprofit incubators to fully commit to supporting emerging social cooperatives.

Countries like Italy, France, Spain, and South Korea have been early supporters of the social cooperative concept, providing enabling legislation to define and provide state support (such as favorable tax treatment) to profit-seeking businesses as long as they can be defined as “social cooperatives” that serve the public interest such as by providing jobs for marginalized communities.

Italy passed legislation enabling social co-ops in 1991—the Act on Voluntary Organizations (no. 266) and the Act on Social Cooperatives (no. 381)—to develop social cooperatives, classified as either “social cooperatives A” or “social cooperatives B.” While type A social cooperatives serve a public interest purpose in healthcare or welfare issues, type B social cooperatives exclusively serve marginalized communities and are required to hire at least 30 percent of their members from vulnerable communities. As a result of this enabling legislation (which provides legal clarity and tax benefits to social co-ops), there are currently more than “11,000 social cooperatives throughout Italy’s 110 provides, with over 700 in Emilia-Romagna.”

In South Korea, social cooperatives were similarly defined in 2012 with the passage of the Framework Act on Cooperatives (FAC). Korean social cooperatives must register as nonprofits, and it is required that at least 40 percent of all activities be dedicated to public benefit. There can be no distribution of individual dividends, even if the organization earns profits. In exchange, social cooperatives get tax exemption for their public benefit work and only pay corporate taxes on the part of organizational income that is not for public benefit work. As of January 7, 2024, Korea reported 3,660 social cooperatives.

Scaling up the US Co-op Movement through Social Cooperatives

Creating a “social cooperative” category in US law would allow nonprofit incubators to fully commit to supporting emerging social cooperatives. 

Defining social co-ops as social purpose organizations could allow such a business tax advantages similar to a traditional 501c3 nonprofit. Moreover, granting legal status to social cooperatives could foster a higher potential for them to win funding from foundations or government programs. In addition, state, county, and city governments could provide local incentives and benefits to social cooperatives.

Another aspect of this is public procurement. Legitimating the social cooperative model could help pave the way to preferential procurement and contract policies emerging from government jurisdictions. Currently, the United States lacks “a consolidated legislative framework for a procurement system to demand and procure social innovation and to provide opportunities to social enterprises offering public services.”

Recognizing the public purpose activities of social co-ops might help inspire progress in this area. There are several models. For instance, Korean national and local governments actively promote social cooperatives through preferential procurement processes. This kind of government support system not only strengthens the infrastructure of social cooperatives but also emphasizes the role of the government in developing a social economy. 

The Future of US Social Cooperatives

Although worker cooperatives are still small, the US worker co-op movement—supported by nonprofit incubators—has grown in recent years. This activity has created a potentially strong foundation for social cooperative legislation.

Now, it is time to define and expand a new type of cooperative—the social cooperative—which can link an income-seeking business model with nonprofit principles. If enshrined in US law, social cooperatives can advance critical economic justice goals and help the co-op movement more fully embrace a key principle, “concern for others,” as part of a broader social transformation mission.

Notes 

1. Maru Bautista, former Center for Family Life staff, interview by Minsun Ji, April 10, 2019.
2. Thierry Volery and Valerie Hackl, “The Promise of Social Franchising as a Model to Achieve Social Goals,” Handbook of Research on Social Entrepreneurship, (2010): 155.
3. Ibid.
4. Elaine Wilson, (2017) “Cooperatives: The First Social Enterprise,” DePaul Law Review 66, no. 4 (2017): 1042.
5. Ibid.
6. Volery and Hackl, “The Promise,” 155.