At one time, credit unions were a well-kept secret. Often they were tucked away in the back of a factory. They did no marketing and offered the plainest of plain vanilla services. All but a handful had a membership that numbered in the hundreds rather than thousands. Most had assets so modest that every loan decision was a major undertaking. Now that credit unions have grown in members, assets, and products and service, not surprisingly, they are pretty well known and are being discovered more and more as time passes. The industry once commonly referred to, as the “sleeping giant” is today wide-awake. Add to the list of those who are now familiar with credit unions, the beloved Internal Revenue Service (IRS). In just the past several months, the IRS has been looking at credit unions from three separate perspectives. Only one of the three could be considered a positive development. Let’s look at them one at a time: Credit Union Times has done extensive news reporting on the effort in a number of states by the federal agency to challenge whether or not state-chartered credit unions are generating what IRS defines as unrelated business income that in its judgment should be subject to taxation as UBIT (Unrelated Business Income Tax). The number of credit unions being audited is still a relatively small number. But if IRS does issue rulings, based primarily on ignorance regarding what a credit union is, how it is structured, and what it does, virtually all state-chartered credit unions could have a problem. Also, some in the know have predicted that if IRS goes crazy with UBIT, it will in effect be giving state-charters just one more reason to possibly seek to convert to a FCU. Still another dual chartering issue? On the positive side, credit unions have rallied to meet this particular IRS challenge head on while the numbers are still relatively small by working with IRS to determine what actually constitutes UBIT from a credit union perspective that also meets the IRS definition of UBIT. Leading the credit union charge is CUNA Mutual Group which of course has a vested interest since it is income generated by some of CMG’s traditional credit union insurance coverage such as life savings and loan protection insurance that are on the list of things to be looked at by IRS. More recently, an IRS scare has been tossed at Corporates. Apparently, an IRS agent has questioned whether or not Corporates are really credit unions. He had never heard of them. By this individual asking his superiors to clue him in, some involved in credit unions made the leap that Corporates might be in jeopardy of losing their credit union tax-exemption. About the time credit union leaders were saying, don’t worry, there is plenty of documentation to support the fact that indeed Corporates are real credit unions and thus entitled to the same tax exemption afforded to natural person credit unions, a credit union news source made a serious mistake. It reported that the IRS had already ruled regarding the Corporates’ tax-exemption. IRS, which makes rulings at a snail’s pace, had done no such thing. Nevertheless, and despite the credit union industry’s optimism that this one will go away, it currently represents IRS challenge number two. Number three has the potential of being big news and good news for credit unions, especially credit union CEOs. As reported in several comprehensive stories in the last two issues of Credit Union Times, an April 9, 2004 IRS private letter indicates that a federal credit union can offer a nonqualified deferred compensation plan under a “for-profit model.” The IRS’s comment on this innovative plan came about as a result of a formal request on behalf of the credit union by an attorney it has engaged. According to that attorney, Lawrence Gallagher, who represents the at-this-point-anonymous credit union, “The biggest hang-up credit unions have had with 457s (a form of retirement plan popular among CEOs) is that because they are non-profits, taxes are paid when (the plan) is vested compared to the for-profit sector, which pays taxes when (the plan) is paid.” Although IRS regs are exceedingly complex, some credit union compensation experts see this development as somewhat of a breakthrough for credit unions looking for ways to hire and retain highly regarded CEOs. In a broader sense, favorable changes to any part of a total executive compensation package will help credit unions be more competitive in recruiting top management talent. But, Gallagher remains cautious because improving the tax consequences of 457s does not mean the elimination of a credit union executive’s personal tax obligation in this area. It would merely change it to something else. Exactly what that is remains uncertain in these early stages. As complicated as this all is and although it will involve not only the IRS but NCUA, lawyers, and a variety of CU organizations, most involved see this as a good sign in dealings with the IRS. Based just on these three recent developments, it has become clear that the IRS still doesn’t really know very much about credit unions. That is dangerous and has many implications for credit unions down the road. Thus it has never been more important for the credit union industry’s leadership group to add to its collective “to do lists” to have more interaction with the IRS and in the process to educate the IRS regarding what credit unions are all about and why they differ from other financial institutions such as banks. Besides the above examples, it has already begun in another area as well. Expect more pro-actions such as CUNA’s letter two weeks ago to the IRS asking why banks were granted permission to convert to Sub Chapter S charters in the first place, but especially in light of banking industry attacks on what they deem as favorable tax treatment for credit unions. Comments? Call 1-800-345-9936, Ext. 15, or Fax 561-683-8514, or E-mail [email protected].

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Peter Westerman


Credit Union Times

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