New Threat To Calif. State Charters: UBIT

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State-chartered credit unions in the Golden State have found themselves facing a new threat from the unrelated business income tax-known as UBIT.

The UBIT is an old bugaboo for state-chartered credit unions across the country that have been hounded, in many cases, by the Internal Revenue Service, over tax liabilities allegedly accrued by tax-exempt entities for activities unrelated to their non-taxable purposes.

As a result, state-chartered credit unions in as many as a dozen states have been audited by the IRS in recent years, with some agreeing to pay tax settlements amounting to the tens of thousands of dollars.

The tax does not apply to federally chartered credit unions.

Now as many as a dozen state-chartered credit unions in California, some among the biggest credit unions in the country, have been contacted by the state's Franchise Tax Board asking them why they haven't filed tax returns accounting for their liability under the state's own UBIT, according to Randy Moore, an attorney representing several of the credit unions.

What Does Tax Board Want?

But its is still not clear what the tax board wants from the credit unions. Some of the credit unions believe it may be a computer glitch, because the state's Form 109 on which UBIT is claimed is the same form those credit unions filed with the Franchise Tax Board to claim franchise tax refunds after the state levy was repealed for credit unions three years ago. But the possibility also exists that the revenue-starved state government, battling to close a mammoth $34 billion state budget deficit, is looking under every rock to raise revenues, Moore conceded. "Part of the problem is we're still not entirely sure what the state is doing," he said.

As with the decades-old dispute with the IRS, credit unions claim the state's tax authorities have no clear standards as to what is considered taxable unrelated business income and what is non-taxable. Credit union representatives are currently working with the IRS to set some kind of standards, as the IRS has claimed the income derived from some traditional credit union products and services, like credit life insurance and ownership in ATM networks, are unrelated activities, and thus, taxable. CUNA Mutual Group, the largest provider of credit insurance products to credit unions, has also been working with the IRS to set some kind of standards.

Could Be a Lot, Could Be Nothing

These products, asserts Moore, should not be considered unrelated to credit union's tax-exempt functions. "They are substantially related to the organizations' exempt functions," he said.

Kim Bannon, vice president for the California CU League, said the credit unions have yet to engage the Franchise Tax Board over the matter because the board has so far requested UBIT returns and not demanded specific tax liability. "Depending on what they're looking for it could be a whole lot of money or it could be nothing," she said. "In time, we may have to go back to them and find out what kind of standards they are working from."

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