WASHINGTON - The IRS has finally gotten around to addressing the Unrelated Business Income Tax (UBIT) as it applies to at least some state-chartered credit unions (SCUs), setting up a fight that could eventually pose a risk to federal charters, as well.
The National Association of State Credit Union Supervisors (NASCUS) and the UBIT Steering Committee, whose members also include CUNA, CUNA Mutual Group and the American Association of Credit Union Leagues (AACUL), have been waiting 10 years for the moment when the IRS would tackle an issue that poses a potential tax liability for SCUs, and inevitably, threatens federal credit unions, as well.
The wait is now over. On March 2 the IRS released Technical Advice Memoranda (TAM) that resulted from the audit of two state-chartered credit unions. The names of the CUs were redacted, but referred to as "T". The IRS concluded the income received by a section 501 (c) (14) credit union from (these) activities are not substantially related to the furtherance of T's exempt purposes and therefore are subject to UBIT: sale of AD&D insurance, sales of MEMBERS financial management services, sale of car warranties, sale of GAP insurance, sale of credit life and credit disability insurance, sale of group life, health and cancer insurance and standalone cancer insurance.
For the other "T" the list included the sale of dental insurance and income from a car-buying service.
NASCUS and the UBIT Steering Committee disagree with the IRS finding that sources of the credit unions' income should be treated as unrelated business income taxable under section 511 of the IRS code, and the Steering Committee said it would challenge the IRS' finding with litigation.
"The IRS will be challenged through litigation eventually," said Mary Martha Fortney, CEO of NASCUS. "It's in the works."
Fortney added the Steering Committee had been working the issue for a considerable time and is fully prepared to meet the challenge. "We strongly disagree with the IRS' determinations that these financial products are not related to a credit union's purpose. It's important that we provide the IRS with education about the modernization of credit unions and the complexity of a credit union member's financial service needs."
For now, it is recommended that SCUs conduct thorough accounting measures of their own in order to gauge any potential tax liability, said Fortney.
While it is likely that whoever challenges the IRS will remain anonymous, the IRS TAMs have made plain their justification for why certain products are deemed taxable. To earn exemption, the agency said "the production or distribution of the goods or the performance of the services from which the gross income is derived must contribute importantly to the accomplishment of those exempt purposes." Those exempt purposes are limited to "promotion of thrift and providing low cost credit for members through mutual and nonprofit operation."
One of the CUs subject to the IRS ruling justified the sale of AD&D insurance as promoting thrift "by providing basic financial protection to members on a mutual basis," and argued it facilitated prompt repayment of loans on a mutual basis by protecting the individual member's financial security." The IRS countered the CU didn't show how such coverage encouraged members who bought it to save, how it helped them obtain credit nor how reduced the CU's cost in providing credit to them. Neither did it demonstrate that its sale advanced the CU's mutual operation or benefited the membership as a whole, the IRS said, opining that it merely benefited the buying member and the CU through the generation of revenue.
Regarding the sale of cancer insurance, the CU claimed it protected against the "potential financial and personal ravages associated with a life-threatening disease, and therefore protected members' financial security." Again, the IRS averred that both dental and cancer coverage carried no incentive to save or nor does it play any role in obtaining credit. The membership as a whole did not benefit, only the individual and the CU, the IRS said.
For car-buying services and car warranties, the credit union involved asserted that cars were essential to maintaining employment and warranties served as collateral on loans and was important to the underlying loan transaction. Repeating its justification that such products did not contribute to the exempt purpose of promoting thrift by encouraging members to save or assist in obtaining credit, the IRS ruled, "...the warranty merely pays for certain car repairs for an individual's car. It does nothing to further the credit union' exempt purpose..."
GAP insurance lessened the "likelihood that a loan secured by that property will go into default and have to be made good from the members' accumulated savings," said the CU. Again, the IRS said it didn't encourage savings or make low-cost credit available. It produces income, therefore is taxable.
Credit disability insurance does promote thrift and encourage savings, said the CU, by repaying debts when the borrower and his/her family finances become strained as a result of disability. But because it is not required for loan approval, is not available for certain types of loans (mortgage and real estate) and its purchase is left entirely up to the individual member (who benefits by not having to repay if a disability occurs) the IRS found its income was taxable.
The CU had conducted no studies to determine which members might need it and no counseling is available to members who have more need than others, said the IRS. Furthermore, bonuses are paid to employees based on the number of policies sold, "providing a profit-motive incentive to T's employees rather than a membership benefit as a whole." Therefore, the primary benefit is to the selling employee. In its sole concession, the IRS found that the sale of checks did further the CU purpose and merited the exemption.
(c) 2007
