WASHINGTON–The credit union tax exemption in the spotlight this week. The House Ways & Means Committee is considering ending it to pay for tax cuts. Credit union trade have been working the issue for months. There have been countless media reports and dueling op-eds. And more than a half-million Americans have sent messages to Congress. But how did the tax exemption come to exist? Not in the way many have assumed.
When President Franklin Delano Roosevelt signed the Federal Credit Union Act in 1934, the federal tax exemption was not included.
Research published in the Southern Business Review in 2010 titled, “100 Years of Credit Unions: Impact of Tax Exempt Status,” by Thomas Noland of the University of South Alabama and Eseard Sibbad of Georgia Southern University, noted that the FCU Act provided that federal credit unions would be set up as taxable entities with a tax burden “not to exceed the rate imposed upon domestic banking.
Instead, in 1937, the tax exemption was primarily established and explicitly included through amendments to the FCU Act out of recognition of the “cooperative and member-owned nature of credit unions” that are “operated entirely by and for their members” on a non-profit basis,” according to its proponents.
Credit unions were not exempt from income taxes prior to the 1937 amendment, which granted federal and state-chartered credit unions an exemption from federal income tax, but there were other exemptions at the state level.
According to research conducted by the Federal Reserve Bank of Richmond, the first credit union tax exemption occurred in 1917 when U.S. Attorney General Thomas Watt Gregory concluded that the 1916 Revenue Act, which exempted mutual savings banks and cooperative banks from federal income tax, applied to state credit unions chartered in Massachusetts.
The Basis for View
“This interpretation was based on his view that credit unions were ‘substantially identical’ to cooperative banks and other mutually owned banking organizations, which were already tax-exempt at the time,” the Federal Reserve Bank stated. “Based on the attorney general’s statement, equal tax treatment of credit unions and other mutually owned banking organizations was warranted because both were mutually organized and had the purpose of assisting ‘those in need of financial help whose credit may not be established at larger banks’.”
The first credit union in the U.S., St. Mary’s Bank, was chartered in New Hampshire in 1909.
Nearly 15 years later after the FCU Act amendments were passed, the Revenue Act of 1951 formally granted the exemption to both federal and state-chartered credit unions even as it temporarily raised both personal and corporate income tax rates.
Reaffirmation in 1998
In 1998, the Credit Union Membership Act, passed after a massive movement-wide effort by credit unions, reaffirmed the tax exemption, emphasizing the cooperative, non-profit nature of credit unions. That legislation also redefined the definition of “groups” in the FCU Act and would eventually pave the way for much larger fields of membership by credit unions seen today.
In 1998, Congress found credit unions, unlike many other participants in the financial services market, are “exempt from Federal and most State taxes because they are member owned, democratically operated, not for profit organizations, generally managed by a volunteer board of directors, and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means.”
Parsing the Language
It is that last piece of language around serving people of modest means that the banking industry has increasingly focused on, arguing before legislatures, Congress and the media that CUs have abandoned that “mission” and that the tax exemption is no longer justified.
It’s a criticism that is being made this week in Washington when the Independent Community Bankers of America holds its meeting in the capital. The ICBA is proposing credit unions of more than $1 billion in assets have their tax exemption revoked.
“The two legislative justifications for the tax exemption — which have remained substantially the same over the last 100 years — are the mutual structure of credit unions and their purpose of assisting those of modest means,” wrote the Federal Reserve Bank of Richmond in its analysis of the tax exemption.
The Federal Reserve Bank of Richmond’s research can be found here.
What Other Studies Have Found
Other studies have also found the tax exemption’s value is passed on to members. A 2016 working paper by Robert DeYoung of the University of Kansas and several co-authors compared a sample of credit unions to comparable banks and found that three-quarters of the subsidy is passed on to credit union members in the form of higher deposit rates.
America’s Credit Unions has also released research indicating American households continue to benefit financially from the tax exemption.
Credit unions in other countries have lost the tax exemptions they once enjoyed, most notably in Canada and Australia. Many in the U.S. have warned losing the tax exemption would imperil the survival of many CUs, and force an even faster pace of consolidation.
A Different View This Week
All of that history, of course, is unlikely to see much light in the Ways & Means Committee this week, which will be much more focused on present and future deficits as it looks for ways to extend the tax cuts enacted in 2017.
