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In 1983 and 1984, petitioner’s bylaws required that
patronage income be determined on the basis of taxable
income rather than book income. The determination of
patronage income was divided into five steps. First,
the total sales for each allocation unit was determined.
Second, the ratios of member and nonmember sales to total
merchandise sales for each allocation unit were
determined. Third, the gross savings for each unit was
determined by subtracting the cost of goods sold from
total merchandise sales. Fourth, the direct expenses for
each allocation unit that did not enter into the cost of
goods sold computation, such as marketing and warehousing,
were subtracted from gross savings to compute “net savings
before adjustments”. If the resulting figure was
positive, then it was reduced by the unit’s allocable
portion of petitioner’s general and administrative
expenses and the losses of units with negative net savings
before adjustments. The resulting figure constituted the
net savings for the particular unit. Fifth, the net
savings for each unit were allocated between members and
nonmembers by applying the ratios determined above in step
two.
Petitioner treated the entire gain realized on the
sale of Terra stock as ordinary income. Petitioner
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