Should Credit Unions Pay Taxes?

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Credit unions got a big reputational boost during the financial crisis, as banking customers protested what in their eyes were reckless lending practices that led to massive bailouts of traditional banks. Especially in the aftermath of the crisis, as banks made numerous attempts to raise fees to recoup losses, many bank customers fled to credit unions for relief.

Yet now, banks are trying to fight back. In Congress, bank lobbyists are waging a battle against credit-union supporters over whether credit unions should continue to benefit from a tax exemption they've had ever since the Great Depression.

The tax argument
Put simply, banks think it's unfair that they have to pay taxes while credit unions don't. Banks are treated just like any other profit-making enterprise, and get taxed accordingly. In the case of the biggest banks, those tax bills can be truly massive. JPMorgan Chase (NYSE: JPM  ) has allowed for income-tax provisions of $8.9 billion on its balance sheet over the past 12 month. Wells Fargo's (NYSE: WFC  ) tax provisions have been even greater, at $9.7 billion.

By contrast, credit unions pay no federal tax. With their structure as member-owned cooperatives, credit unions plow their profits back into their banking products, offering higher interest rates on their deposit accounts, and lower rates on loans.

A patchwork of tax rules
Both banks and credit unions have strong arguments for their respective positions. But the sad truth is that similar disparities exist throughout the tax code. Consider the following:

  • In the educational industry, most traditional colleges and universities are exempt from tax. But for-profit educational providers do pay federal tax on their profits. Apollo Group (NASDAQ: APOL  ) , which operates the University of Phoenix, made provisions for almost $200 million in income-tax expense over the past year. Some tax advocates have suggested taxing the endowment income of large universities, which currently falls under their tax exemptions. Using Yale's $19 billion endowment as an example, returns of 4.7% in its most recently reported fiscal year would equate to roughly $900 million in potentially taxable income.
  • In the health-care business, many hospitals are structured as tax-exempt charitable organizations. Yet, some have argued that, under Obamacare, the number of uninsured patients will drop enough to make it difficult for tax-exempt hospitals to provide enough care to uninsured patients to meet state regulations governing their charitable status. Private hospital owner HCA (NYSE: HCA  ) made provisions for $820 million in income-tax expenses over the past 12 months.
  • In the energy industry, there's been a huge drive among ordinary corporations to restructure all or part of their operations to qualify for status as master limited partnerships. MLPs don't have to pay tax at the entity level, instead distributing their profits, and leaving unitholders to bear any tax liability from their operations. Investors in ordinary corporations end up getting double-taxed, with the companies themselves paying corporate tax, and shareholders still paying individual taxes on dividends.

In that light, the tax-exempt status of credit unions doesn't seem all that peculiar. Arguably, what's unusual about banking is that more institutions haven't moved to take advantage of the exemption. Credit unions still make up only a small fraction of the banking-services industry, with traditional banks having about 15 times the financial assets that credit unions hold.

Don't fret about credit unions
For-profit banks might not like what they see as a competitive disadvantage against credit unions. But, given the benefits that larger banking institutions gain from their relative size, keeping tax-exempt status for credit unions doesn't seem like an unfair way of keeping the playing field relatively level.

Investors in for-profit banking institutions also shouldn't worry about credit unions as a big threat. The fact is that banks are still highly profitable, yet their stock prices don't fully reflect their future potential. Bargains of a lifetime are still available, but you need to know where to look. The Motley Fool's new report, "Finding the Next Bank Stock Home Run," will show you how and where to find these deals. It's completely free -- click here to get started.

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  • Report this Comment On September 12, 2013, at 7:34 PM, PeteH66 wrote:

    Of COURSE it's big-bank lobbyists fighting to impose taxes on community-owned credit unions: as tiny as the CUs are, they represent competition for the big boys. These taxes are a TERRIBLE idea. I bank at a CU in a small town in upstate NY, and my CU was the only place willing to refi my commercial rental property at a reasonable rate. Why? Because I, like many of my neighbors, am a member, and because the CU -- also residents of our community -- recognized that lending to my business was a benefit to that community.

    Compare that to BofA, through whom I used to process credit card payments. From 2011 to 2012, although my billings they processed declined by $8,000 -- my card processing fees INCREASED by $600.

    In the words of Jimmy Stewart, "This town needs this measly one-horse institution if only to have some place where people can come without crawling to Potter."

  • Report this Comment On September 13, 2013, at 2:48 PM, MyraD wrote:

    On the American Bankers Association website, it states, “If credit unions want to act like banks, they should be taxed like banks.

    But, let’s be real. As with most other business-related issues, this is about the bottom line. One type of business (banks) believes another (credit unions) has an unfair tax advantage and wants to level the playing field to boost its profits. Keep in mind the playing field here is 94% owned by for-profit banks and 6% owned by credit unions. I guess they have a different definition of “level playing field”, or maybe they just won’t be satisfied till they have it all. Just think about what it will be like if the banks had zero competition. Because this is exactly what will happen as most credit unions would simply go out of business if the exemption is taken away. Many recent studies show that loan rates would rise, fees would go up and convenience would go down for ALL banking customers.

    A bank’s first priority is to maximize shareholders’ profits—from the rates and fees it charges customers for loans and other services. A credit union’s top priority is to serve members with exceptional customer service, products, and services at fair prices. Any retained earnings go back into raising capital for the credit union. Unlike banks retained earnings are the only way credit unions can raise capital.

    Here is a little history to put all this in context and show how this worn out argument is as silly today, as it has been for the past several decades. The 1934 Federal Credit Union Act (FCUA) stated credit unions receive a tax exemption because "credit unions are mutual or cooperative organizations operated entirely by and for their members." Credit unions are eligible for tax-exempt status if they meet the following criteria:

    •Operating on a not for profit basis

    •Organized without capital stock

    •Operating for mutual purposes

    The reason for-profit banks don’t qualify is because they cannot meet the criteria. By the way any bank can change its charter to meet these criteria and become a credit union to take advantage of this tax exemption. But none of them do, because they know it’s really not an advantage.

    All of this was reaffirmed in 1998, as part of the findings of the Credit Union Membership Access Act. Congress found that, "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."

    Still, credit unions do pay many taxes and fees, among them payroll and property taxes. It is also important to note that share dividends paid to credit union members are taxed at the membership level. Critics argue that credit unions today are no different than banks. However, the defining characteristics of a credit union, no matter what the size, remain the same today as they did in 1934. A credit union's shareholders are its members and each member has one vote, regardless of the amount on deposit, while a bank has stockholders.

  • Report this Comment On September 13, 2013, at 4:44 PM, Paul538 wrote:

    Banks are disingenuous when they claim that credit unions are "just like" banks. Credit unions are member-owned cooperatives, operating not-for-profit. Bankers can be creative, so I'm sure they could figure out a way for ALL of their depositors/customers to vote in electing the bank's Board of Directors from the customer base. THAT would bring substance to their argument that banks and credit unions are alike. The banks' for-profit motive, their need to generate profit for a concentrated group of stockholders above and beyond what is paid back to customers, are differences in the very essence of how and why the banks operate. More and more credit unions are giving extra payouts to their members if the credit union has extra profits, beyond what they need to build capital that is required. When is the last time you heard of a bank having a super-profitable year and deciding to pay back some of those earnings to their customers (not stockholders)? Look at what banks DO with their earnings, and you'll quickly realize that credit unions operate for the benefit of the average consumer, not to enrich a concentrated group of stockholders and highly-compensated bank executives.

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