Nothing rallies credit union concerns like taxation, and few taxation threats have been as real as the Internal Revenue Service’s Unrelated Business Income Tax activities. Better known as UBIT, this federal tax is being held out by the IRS as the basis for taxing many products offered by state-chartered credit unions that the IRS feels represent income sources unrelated to the institutions’ primary goal of promoting thrift and serving member needs. The IRS seeks to lay the groundwork for broad collection of credit union UBIT tax through issuance of Technical Advice Memoranda, or TAMS, to its field auditors that address specific activities of certain audited credit unions.

 

CUNA Mutual, along with CUNA & Affiliates, the National Association of State Credit Union Supervisors (NASCUS) and the American Association of Credit Union Leagues (AACUL) formed a steering committee that has been active in studying and addressing UBIT concerns, as well as communicating with credit unions and regulators. Larry Blanchard, a CUNA Mutual senior vice president and chair of the UBIT Steering Committee, set some time aside to address the threats posed by UBIT.

 

 

A: UBIT, which we’ve been studying and working to combat for more than 10 years, is a federal tax applied to the net income from those products andservices offered by nonprofit and not-for-profit institutions that the IRS doesn’t feel are appropriate to the institution’s mission. For example, if the YMCA started selling cars, profits from those sales would be taxable under UBIT because they don’t meet the Y’s mission of offering health, educational, and recreational services. Among credit unions, only state-chartered institutions are affected. Federally chartered credit unions are exempt from UBIT.

 

Recently, the IRS issued five separate TAMs to its field auditors that named a number of financial products sold by unidentified state-chartered credit unions that the IRS said were subject to unrelated business income tax. Those TAMs specifically identified credit union sales of credit life and disability insurance; accidental death and dismemberment (AD&D) insurance; securities and investment products, including MEMBERS financial management services; car warranties; guaranteed auto protection (GAP) insurance; and dental and cancer insurance.  An additional TAM, expected to be published soon, also maintains that income from nonmember ATM transactions is subject to UBIT.

 

It’s an important victory for credit unions that interchange income from credit and debit card transactions is exempt from UBIT. The sale of checks and collateral protection insurance also is not subject to UBIT,

 

 

A: On its face, UBIT presents financial challenges to credit unions that offer these products, but perhaps not big challenges and certainly not insurmountable ones. Profits on the sale of one product, for example, can be offset by losses on another product, with the IRS taxing the net profit for all covered products.  In addition, the tax applies only to net income as determined after allocation of all reasonable expenses.

 

What credit unions really need to remember is that TAMs are applied to specific institutions on a case-by-case basis. The IRS did not issue a general Revenue Ruling that would have more clearly drawn all credit unions into its net.  At present, although the TAMs are instructive of the IRS viewpoint and will influence IRS, IRS auditors’ and private auditors’ thinking, the applicability of UBIT to individual institutions depends on each institution’s unique circumstances. Credit unions that are unsure should consult with their auditors. Failure to comply could expose a credit union to interest and penalties.

 

The bigger threat, of course, is that the bankers will see this as an open door and lobby for other types of taxation. This may put new wind in their sails to increase their credit union taxation efforts.

 

 

The four member organizations and state credit union leagues have committed significant funding and staff time to study this situation, interact with the IRS to try to influence its thinking, and prepare for litigation. We’ve all provided our members with accounting tools through our Web sites to help credit unions measure UBIT’s potential impact. Despite such contingencies, we clearly feel the IRS direction is wrong and that the products identified as taxable are intrinsic to every credit union’s exempt purpose of promoting thrift by providing financial services on a mutual and not-for-profit basis.

 

Although we have tried to work with the IRS to arrive at an administrative solution, the IRS continues to dig in its heels.  So it looks like we’ll have to seek redress through the courts and challenge the IRS’ misguided reasoning and conclusions through litigation.

 

 

A: The most important thing for credit unions to do is not panic. This is part of a lengthy, ongoing process that will continue to play out over the next 2-3 years at least. Good financial management will help credit unions minimize threats from UBIT.  Ultimately, we believe that the IRS’s position on this matter will be proven wrong for many traditional financial products.

 

© CUNA Mutual Group 2007.  Used with permission.

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