Combating Challenges in the State System: UBIT, Federal Preemption Take Center Stage
Many in the financial services industry have kept a close eye on the federal preemption case Watters v. Wachovia brought before the U.S. Supreme Court in November 2006. It was the first banking preemption case heard by the U.S. Supreme Court in 10 years.
Linda Watters, commissioner of the Michigan Office of Financial and Insurance Services, is challenging the interpretation of regulations from the Office of the Comptroller of the Currency, which shields parent companies and their subsidiaries from state laws and the enforcement of state authorities.
While the outcome of this case might not directly impact credit unions, decisions concerning federal preemption affect the interpretation of state laws and how federal entities interact with state institutions. Protecting state authority and credit union dual chartering are core principles for NASCUS as an organization. This year, NASCUS will continue its efforts to protect these principles as they affect issues including unrelated business income tax, safety and soundness concerns and emerging regulatory issues.
As many of you know, the Internal Revenue Service recently released a technical advice memoranda on UBIT. The UBIT Steering Committee, made up of NASCUS, CUNA, CUNA Mutual Group and the American Association of Credit Union Leagues, has monitored UBIT for more than 10 years.
Some of the decisions of the IRS are good news for state-chartered credit unions. The UBIT Steering Committee expects that the IRS will regard the following income sources as related to a credit union's business: interchange fees from debit and credit card transactions; ATM fees from members; the sale of checks to members; and the sale of collateral protection insurance to members.
Conversely, the UBIT Steering Committee intends to challenge other IRS decisions through litigation. The IRS considers the following income sources as unrelated to the business of credit unions: income from the sale of most insurance and insurance-related products; the sale of securities and investment products; income from nonmember ATM fees; and income from auto buying referral services.
NASCUS is concerned that a federal entity, like the IRS, presumes to define characteristics of an institution that is created, chartered and regulated under state law. Through litigation, the UBIT Steering Committee hopes to successfully challenge the IRS and provide education about the modernization of credit unions and the complexity of a credit union member's financial service needs. We will also emphasize that state law definitions of a credit union's purpose should be considered in the IRS' determinations of UBIT. It is critical that the IRS understands the modernization of credit unions and their services. The IRS views credit unions as institutions that help consumers with thrift. But, many of today's consumers don't save in the conventional way--they use investments and complex financial services to build wealth and savings. Credit unions have evolved over the years to serve the needs of the modern financial services consumer.
State regulators and state legislatures have long recognized the fundamental financial services powers, which allow credit unions to serve their members. They also understand the evolving nature of consumer needs to improve economic standards and sustain loss in a complex financial environment.
While UBIT poses no immediate threat to federal credit unions, protecting the strength and viability of dual chartering is important to all credit unions. On the surface, UBIT appears to only affect state charters. But, the implications of one charter's challenges are not always isolated. The challenges of one charter are the challenges of every charter, each is key to preserving innovation, diversity and the progressive nature of today's credit unions.
NASCUS and the UBIT Steering Committee encourage state credit unions to utilize sound accounting principles to assess potential tax liability. Appropriate expense allocation will reduce the amount of income, if any, subject to tax. UBIT resources are available through the UBIT Steering Committee on NASCUS' and CUNA's Web sites at www.nascus.org or www.cuna.org.
At the end of the day, when a federal government entity, like the IRS or a federal regulator, substitutes its judgment for that of the states about the structure of state institutions, it can be harmful to dual chartering. The unique nature of dual chartering and the modernization of credit unions must be recognized and understood by policymakers. In addition to NASCUS' efforts to address UBIT in 2007, state regulators are finishing the state data collection project for the U.S. House Ways and Means Committee. The project serves as another mechanism to inform policymakers about the state credit union system and the importance of dual chartering. Further, the commitment of the state regulators to respond to the House Ways and Means Committee demonstrates that the state system is capable and willing to manage its affairs.
From a regulatory perspective, NASCUS will continue to work with the state system to manage safety and soundness concerns related to information technology, indirect and mortgage lending, disaster preparedness, conversions and other operational and philosophical challenges that will define the state system in the years to come.
Recognizing that emerging issues are not always isolated to one charter, or even limited to credit unions, is what will enable the credit union system to continue thriving into the future. In addition, federal bodies must recognize the states as their partners and resist the urge to so quickly substitute their judgments for that of the capable state system.