Federal credit unions are cashing in on a double tax exemption

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Credit unions are grifting taxpayers twofold because they are exempt from most federal, state, and local taxes, and are subsidized by an arcane entity housed within the U.S. Treasury Department: the Community Development Financial Institution, or CDFI, Fund. Credit unions' tax status also conflicts with CDFI requirements, raising questions about their current tax treatment.

Congress should hold hearings to investigate whether credit unions should still benefit from subsidies even while they continue to operate outside the bounds of their original mission to provide loans to people of modest means.

The Internal Revenue Service exempts federally chartered credit unions from most taxes under section 501(c)(1) of the Internal Revenue Code. Because of the tax designation, the IRS finds that federal credit unions are instrumentalities of the federal government. This enables federal credit unions to avoid filing Form 990s like other nonprofits, but it also raises questions about credit unions' participation in the CDFI Fund.

The CDFI Fund was created by the Riegle Community Development Regulatory Improvement Act of 1994 "to promote economic development in distressed urban and rural communities." The Fund underwrites loans, grants, or equity investments for financial institutions that qualify for a CDFI designation, such as credit unions, banks, microloan funds, and venture capital funds.

Federal law and regulations raise the question of whether federal credit unions should qualify as CDFIs. According to the Treasury Department's CDFI application, "A CDFI cannot be an agency or instrumentality of the United States, any state or political subdivision." This follows federal statute, which states that a CDFI "is not an agency or instrumentality of the United States, or of any State or political subdivision of a State." Additionally, federal regulations state that "a CDFI shall not be an agency or instrumentality of the United States, or any state or political subdivision thereof." Since the IRS deems federal credit unions to be government instrumentalities, the qualifications for the CDFI program and federal credit unions' tax status appear to conflict with each other.

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The discrepancy has allowed credit unions to make up the largest share of CDFIs' total assets, about 65%, according to 2023 data. Currently, 444 credit unions are designated as CDFIs, and of that number, 194 are federal credit unions. Banks were the runner-up at 26%, followed by loan funds at 8.7% and venture capital funds at 0.8%. Credit unions are heavily subsidized by taxpayers through the CDFI Fund, contributing to the unprecedented growth of credit unions across the country.

There are significant benefits for a credit union when it becomes a CDFI. As a CDFI, credit unions are exempt from certain regulations, such as the member business lending cap, and the CFPB's prescriptive qualified mortgage and ability to repay rules. This allows a credit union to circumvent current lending restrictions in federal law and underwrite more loans to borrowers who have a greater chance of not being able to pay back their loans. Taxpayer dollars are being used as a backstop in the event borrowers cannot repay and credit unions ultimately take a loss. The American taxpayer should not have to subsidize credit unions twice — once for being tax-exempt and a second time by paying for the CDFI Fund.

Credit unions designated as CDFIs have a dual subsidy advantage. They are tax-exempt and receive a subsidy from the CDFI Fund, which gives them a large competitive advantage over community banks. The CDFI Fund should not provide permanent support to financial institutions that are already benefiting from a tax exemption.

As the Trump administration continues to pursue future revenue neutral tax reform and prioritize major spending cuts, including a recent executive order targeting subsidies for the CDFI Fund, Congress should take the opportunity to hold hearings and investigate credit unions' tax-exempt status. Federal credit unions have expanded beyond their original mission and are now operating on the same level as some of the largest banks in the U.S., all at the American taxpayer's expense. It's up to Congress to create a level playing field, and that starts with proper oversight.