WASHINGTON — The firestorm over the IRS' Unrelated Business Income Tax rule has ignited again and will very likely lead to a lawsuit.

IRS agents in Connecticut and Alabama have issued Technical Advice Memorandums to state chartered credit unions that have ruled that credit insurance and nonmember ATM fees are subject to UBIT. Though TAMs were only issued in those two states, TAMs are precedent-setting and are considered to be IRS' national policy.

UBIT has been an on-and-off issue for years in the credit union industry, 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 if income should be subject to UBIT. (1) It is a trade or business, (2) it is regularly carried on, and (3) it is not substantially related to the furtherance of the exempt purpose of the organization. When there is $1,000 or more in gross income that meets these criteria, organizations are required to file IRS Form 990-T to report the income.

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

CUNA Mutual has played a lead role in battling the IRS, going back to former president Mike Kitchen's days. Today, CUNA Mutual is taking UBIT just as seriously as the IRS has ruled virtually all insurance-related products, with the exception of collateral protection insurance, would be subject to UBIT.

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

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

Howard Pitkin, commissioner of the Connecticut Department of Banking has been very close to this issue. Pitkin believes the IRS is not treating credit unions fairly, especially on the charter distinction of UBIT. “The fact that the IRS is imposing taxes on state charter credit unions that they are not imposing on federally chartered 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 to tell you about where else they are doing it, but we know they are not in federally chartered credit unions,” said Pitkin, who believes the IRS is trying to weaken the state system. He said Connecticut has already seen state charters convert to federal over UBIT. Pitkin noted that Connecticut has a number of small state charter CUs who have been intimidated by IRS' aggressive stance on UBIT in Connecticut.

As for parity with federal charters, Pitkin offers the example of a church bake sale. He said taxing state charters, but not federal is akin to two churches having a bake sale on opposite sides of the street. They are selling the same product at the same price, but one of the churches is taxed and the other is not. “How are federal charters instrumentalities of the government any more than state charters? That whole idea of an instrumentality needs to be looked at,” he said.

But the UBIT Steering Committee does not view this as a federal vs. state issue, said Blanchard. The issue is letting the IRS define what a credit union is, said Blanchard. He noted that although NAFCU is not officially on the committee, they have been very involved in the committee's work. NAFCU President/CEO Fred Becker said he has offered up NAFCU's resources to help fight UBIT even though it does not directly affect federal charters.

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

With litigation the agreed upon action, now it's time to find the right plaintiff said CUNA General Counsel Eric Richard. That might be easier said than done. Richard noted that being the plaintiff is a time consuming process for the credit union and their books will be on display to be analyzed for UBIT activity.

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

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

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