WASHINGTON — The firestorm over the IRS' Unrelated BusinessIncome Tax rule has ignited again and will very likely lead to alawsuit.

IRS agents in Connecticut and Alabama have issued TechnicalAdvice Memorandums to state chartered credit unions that have ruledthat credit insurance and nonmember ATM fees are subject to UBIT.Though TAMs were only issued in those two states, TAMs areprecedent-setting and are considered to be IRS' nationalpolicy.

UBIT has been an on-and-off issue for years in the credit unionindustry, but resurfaced in 2003 when credit unions in Connecticut,Alabama and Colorado were audited for UBIT.

There are three factors the IRS considers when determining ifincome should be subject to UBIT. (1) It is a trade or business,(2) it is regularly carried on, and (3) it is not substantiallyrelated to the furtherance of the exempt purpose of theorganization. When there is $1,000 or more in gross income thatmeets these criteria, organizations are required to file IRS Form990-T to report the income.

UBIT only applies to state chartered credit unions. Federalcharters, considered “instrumentalities” of the federal government,are exempt.

CUNA Mutual has played a lead role in battling the IRS, goingback to former president Mike Kitchen's days. Today, CUNA Mutual istaking UBIT just as seriously as the IRS has ruled virtually allinsurance-related products, with the exception of collateralprotection insurance, would be subject to UBIT.

“We have been at this for more than 10 years. It gets to what isthe purpose of a credit union. We firmly believe that creditinsurance is closely related to the purpose of a credit union. Itprotects the credit union and the member,” said Larry Blanchard,senior vice president of CUNA Mutual.

CUNA Mutual, along with CUNA, NASCUS and the AmericanAssociation of CU Leagues, make up the UBIT Steering Committee. Thecommittee now believes it must fight the UBIT battle in court. “Ifwe don't fight that battle now, we open up a chasm. Where does itend?” said Blanchard.

Howard Pitkin, commissioner of the Connecticut Department ofBanking has been very close to this issue. Pitkin believes the IRSis not treating credit unions fairly, especially on the charterdistinction of UBIT. “The fact that the IRS is imposing taxes onstate charter credit unions that they are not imposing on federallychartered credit unions is laughable. The IRS is a big phantom.They don't have to tell you who tipped them off, they don't have totell you about where else they are doing it, but we know they arenot in federally chartered credit unions,” said Pitkin, whobelieves the IRS is trying to weaken the state system. He saidConnecticut has already seen state charters convert to federal overUBIT. Pitkin noted that Connecticut has a number of small statecharter CUs who have been intimidated by IRS' aggressive stance onUBIT in Connecticut.

As for parity with federal charters, Pitkin offers the exampleof a church bake sale. He said taxing state charters, but notfederal is akin to two churches having a bake sale on oppositesides of the street. They are selling the same product at the sameprice, but one of the churches is taxed and the other is not. “Howare federal charters instrumentalities of the government any morethan state charters? That whole idea of an instrumentality needs tobe looked at,” he said.

But the UBIT Steering Committee does not view this as a federalvs. state issue, said Blanchard. The issue is letting the IRSdefine what a credit union is, said Blanchard. He noted thatalthough NAFCU is not officially on the committee, they have beenvery involved in the committee's work. NAFCU President/CEO FredBecker said he has offered up NAFCU's resources to help fight UBITeven though it does not directly affect federal charters.

“This is an issue for the whole industry. We do not need anymore narrowly defined definitions of what a credit union is outthere. That's bad for all credit unions,” said Becker.

With litigation the agreed upon action, now it's time to findthe right plaintiff said CUNA General Counsel Eric Richard. Thatmight be easier said than done. Richard noted that being theplaintiff is a time consuming process for the credit union andtheir books will be on display to be analyzed for UBITactivity.

Richard said it's important that the committee find the rightcredit union in the right state. Alabama, one of the battlegroundstates, doesn't have the most favorable profile for such a case,said Richard. He pointed to Wisconsin as the ideal location tobring the suit so far.

Blanchard stressed that credit unions have to work together topresent the best-case scenario. “We want to make sure it is theright credit union with the right product mix. What we don't wantto have happen is a credit union that is well intended, but perhapsdoesn't have the right blend, voluntarily going out on its own tochallenge UBIT,” said Blanchard.

In the meantime, the committee is advising credit unions tobegin accounting for UBIT so it can be prepared for audits. Thecommittee has put out a UBIT toolkit to help credit unionsunderstand and prepare for UBIT. Also, at press time NASCUS was setto host a UBIT seminar in Texas on Jan. 25 and the UBIT SteeringCommittee has two Webinars slated for early February.–[email protected]