These IRS Technical Advice Memorandums (TAMs) conclude that state chartered credit unions earn unrelated business taxable income (UBTI) by selling various types of insurance to depositors/members. UBTI is income earned by an exempt entity that it taxed to the entity because it is earned in an activity that is unrelated to the entity’s exempt function. These TAMs appear to be a major setback for state chartered credit unions in their long tussle with commercial banks over what the banks see as their unfair tax exemption.
Brief History of Credit Union Taxation
Credit unions were exempt by ruling and regulations prior to 1951 and became exempt by statute under the Revenue Act of 1951 when savings banks lost their exemption. Of course one of the most famous products of mutual savings banks has been savings bank life insurance, invented by none other than Louis D. Brandeis before he joined the Supreme Court. Mutual savings banks had only one year to live under the tax on unrelated business income of exempts, which was enacted in the Revenue Act of 1950.
Presumably the Bureau of Internal Revenue did not move against mutual savings banks in that year to collect tax on unrelated income, and the same has been true of insurance sold by credit unions, at least up to now.
The TAMs’ Reasoning
The TAMs found no case law involving state credit unions, other than dicta in one case. They relied, instead, on the group benefit versus individual services distinction that has generally applied to services offered trade association members for a fee. These authorities are based on the exempt purpose of trade associations, which is to benefit the group as a group.
The TAMs cited the 1917 attorney general’s opinion that first ruled credit unions to be exempt because they provided “savings accounts and loans to members who may not be served by banks in a non-profit and mutual manner.” In those days credit unions generally operated on a “much smaller scale” than even savings banks and cooperative banks.
Once the TAMs translated this history into the exclusive exempt function of credit unions, they had little difficulty concluding that various kinds of insurance, car warranties and the like produced UBTI. Only income from selling checks to depositors was ruled to be exempt from the tax on UBTI.
News reports indicate that the state credit union associations have been gearing up to fight this and related issues for several years. Litigation and possibly legislation may be in the offing.