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WASHINGTON – The Internal Revenue Service is by no means letting up on its interest in Unrelated Business Income Tax and how it relates to credit unions. The latest update on UBIT came via an Oct. 29 Webinar on the state-of-the-state of UBIT. It was held by the UBIT steering committee, which includes CUNA Mutual, NASCUS, CUNA and the American Association of Credit Union Leagues. UBIT of course has come on strong this year as UBIT audits have cropped up in three states. To date, there have been six in Alabama, eight in Colorado and 44 in Connecticut. UBIT is designed to tax tax-exempt entities on income that is substantially unrelated to their exempt purpose. CUNA Mutual SVP of Corporate and Legislative Affairs Larry Blanchard said although UBIT audits have primarily been focused in Alabama, Connecticut and Colorado, that “is about to change.” “The IRS has confirmed that it intends to expand its activity.The IRS is not convinced that credit union powers equate to the purpose to which tax exemption was granted,” said Blanchard. UBIT is a touchy issue on so many levels. CUNA General Counsel Eric Richard pointed out that the IRS is now on a fact-finding mission to try and get an understanding of how credit unions have evolved and if they have stayed true to their tax exempt purpose. Part of that fact-finding mission means calling on credit unions’ number one nemesis – the bankers. “Our adversary may well have to provide input to the IRS. The banking industry argues that credit unions should stay small. Their idea is we should be offering share accounts and simple consumer loans and that’s it,” said Richard, noting that he believes the IRS won’t buy that argument in today’s current financial landscape. Richard said the key is to broadly define credit unions to the IRS. By using a broader definition of what a modern credit union is, more income should be outside the scope of UBIT, he said. What Falls Under UBIT? The $10,000 question remains what credit union products and services does the IRS think should fall under UBIT? There is no answer right now, and Richard said the process to get there is going to be very slow. The bad news is the result is not guaranteed. The IRS could conceivably come back with a host of things that it believes fall under UBIT. The IRS is questioning all sorts of products, including credit life and disability, sale of checks, collateral protection and GAP insurance, AD&D and group life insurance, non-member ATM fees, debit-financed income (essentially the CU borrowing money at a rate lower than the rate of return it gets on an investment it makes (commonly known as arbitrage)), and interchange fees. Richard said the IRS has also been clear that it is unwilling to stop current audits or hold back on future ones. “The IRS sees them as fact gathering mechanisms,” he said. The good news, however, is that the IRS seems willing to use the Technical Advice (TA) process now. This means a credit union can challenge a product falling under UBIT and the IRS examiner asks for TA from Washington, which as already stated is on a massive fact finding mission trying to understand credit union evolution. That would likely delay any UBIT a CU would have to pay on products and services challenged. Three Ways to Fight Big, Bad UBIT There are three ways to fight UBIT outlined by the steering committee: administrative, litigate or legislate. The administrate end is what the group is doing now by challenging audits and asking for TAs. Richard said with the credit union industry’s increased power on Capitol Hill, some CUs may be wondering why the industry isn’t trying to legislate its way out of the UBIT box. He said that would be a mistake at this point because it could wind up hurting federal charters. Federal credit unions’ exemption is based on them being considered, very broadly, instrumentalities of the federal government. Congress would likely focus on this issue if it were asked to give state charters and federal charters parity on UBIT. Richard said that’s undue focus CUs do not need to have Congress engaging in. “There’s a risk we could get adverse results,” said Richard. The litigation side of things however is in the works. Faye Patzner, an attorney with CUNA Mutual, said the UBIT steering committee is already preparing its legal attack. She noted that IRS’ opinion on UBIT is not the law, and can be battled in court. Patzner said the group is actively looking for plaintiffs for a suit against the IRS. It doesn’t mean a suit is imminent, but they want to prepare one should credit unions receive some unfavorable rulings. But finding a plaintiff credit union isn’t easy. “While credit unions felt strongly about what’s related and not related, they have some reluctance to be a plaintiff,” said Patzner. She said the group is considering how the CEO of the plaintiff CU would handle the witness stand, the type of FOM of the CU, its product mix, as well as its state act. All these things would have to be just right to find the ideal candidate, she said. Patzner gave some interesting insight into what products she thinks CUs have a strong case for in terms of not being subject to UBIT. She said she feels confident that interchange income and check sales would hold up against UBIT, but gave insurance products only a 50/50 chance and said ATM fees could be very vulnerable as well as non-member income. Patzner said the simple definition that the IRS should be using to determine what falls under UBIT is the following; “(Products and services that) keep a credit union competitive in the financial environment today.” One of the intriguing things about Webinars, is they allow for instant online polls. One poll asked if the credit union would be willing to be a plaintiff bringing suit against the IRS. Only 10% said yes, while 13% said no, 28% probably not, and 48% maybe. Another poll asked what form of income the credit union finds most important to get a clear resolution for in terms of UBIT. The number one source was interchange income with 64% considering that the most important form of income to not fall under UBIT. Next was credit insurance at 30%, and investment and annuities at 11%. A key aspect of UBIT is the CU being able to track the income and expenses of each product and service it offers. Webinar participants were polled on having the ability to do this via systems currently in place. Some 58% said they did have this available for both income and expenses tracking, while 22% said they don’t track income and expenses by product. Another 16% said they do it for income only, while 2% tracked for expenses only. The loudest message coming from the steering committee during the Webinar was for any credit union that is contacted by the IRS in terms of UBIT to contact their credit union league. They said in some early cases this did not happen and the lack of a united front is part of why credit unions are in this situation. [email protected]

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