WASHINGTON (4/9/14, UPDATED 2:20 p.m. ET)--Credit unions have received a much-sought-after interpretation by the Internal Revenue Service that clears nearly all credit union products from being subject to unrelated business income tax (UBIT).
Finally bowing to the results of two federal court cases brought by credit unions, the IRS recently issued a memorandum that defines nearly all credit union products at stake in the litigation as "substantially related income"--not subject to UBIT.
"This is clearly a breakthrough with the agency," said Larry Blanchard, chairman of a coalition of credit union groups that has supported the litigation. "It signals that credit union tax refunds for past UBIT payments should now be processed."
He also emphasized that the IRS action bolsters credit union arguments that future payments to the IRS of UBIT on these same products may not be due.
"Credit unions should talk this over with their tax advisers. In any event, this is a welcome development for credit unions," Blanchard observed.
He added that the IRS memo reflects the agency's appreciation for rulings of the courts: That the credit union mission to serve members extends well beyond loans and savings accounts.
The coalition, called the UBIT Steering Committee, is comprised of representatives of the Credit Union National Association, CUNA Mutual Group, the American Association of Credit Union Leagues and the National Association of State Credit Union Supervisors.
According to a three-page, March 24 "memorandum for all exempt organizations employees"--geared toward IRS examiners of exempt organizations, such as credit unions--revenue from the following income-producing activities are deemed by IRS "substantially related income" not subject to UBIT:
Royalty income from the marketing of accidental death and dismemberment (AD&D) insurance to credit union members is also exempt.
IRS has also indicated it will incorporate the memo into its Examination Manual to guide future audits of credit unions.
"After 15 years of work--and millions of dollars in litigation expenses--it is ironic that a breakthrough in the struggle of this scope comes down to a three-page memo," Blanchard said. "But the effort has been entirely worth the time and money, particularly for those credit unions who have filed their returns and made payments in the past."
In 2009, a jury in federal court ruled in favor of Community First CU, Appleton, Wis., as UBIT related to three insurance products; credit life and credit disability insurance and GAP products. The jury found that these products were substantially related to the tax-exempt purposes of credit unions.
In 2010, a federal court in Colorado ruled in favor of Bellco CU. The Greenwood Village, Colo.-based credit union challenged UBIT on income from many of the same products through its Direct Lending Program and its Indirect Lending Program for the tax year 2003 and the portion of tax year 2001 for which it had accurate income records.
As to the impact of the IRS guidance on future tax liabilities, neither the UBIT Steering Committee nor any of its members can provide tax advice to credit unions. The committee urges credit unions to consult with their tax advisers on whether the IRS pronouncement, combined with the previous court rulings, provide "substantial authority" to refrain from reporting the affected categories of income in the future. In the past, a law firm retained by the Steering Committee has provided a general opinion on the impact of the court cases on the "substantial authority" issue. (Use the second resource link to access this opinion.)
There are, Blanchard pointed out, some remaining issues to be resolved related to the March 24 IRS memo.
"However," he noted, "this development gives us great hope that real light is at the end of the tunnel, and that credit unions will be able to offer products and services to their members in the future with a significantly diminished threat of having to pay this tax."
Use the first resource link to access the IRS memo.