State Governmental Affairs

American Bankers Association's Arguments for State Taxation of Federal Credit Unions and the Preservation of the Dual Chartering System

In 1937, Congress prohibited state and local governments from taxing federal credit unions. Currently, federal credit unions are exempt from all federal, state and local income, along with sales and excise taxes as well as franchise taxes.

A major policy issue that arises from the federal tax exemption is that the federal prohibition limits the ability of states to craft and implement the most efficient tax policy. The abolition of this federal prohibition is particularly important in the current economic environment, where states are facing mounting budgetary pressure.

When the Federal Credit Union Act (12 USC 1768) was originally enacted, Congress determined that the credit union industry was in its infancy and served a niche market, and thus, it should be protected. The argument behind this legislation was that state taxation would impose an excessive burden on the fledgling federal credit union industry and thus curbing their development. Further, the tax exemption was closely linked to the character of early credit unions as limited organizations with a distinct common bond.

Today, credit unions have evolved from niche players to mainstream financial institutions. They offer a wide range of financial products and serve ever-increasing membership bases that, in many instances, make them indistinguishable from banks. These institutions are extremely profitable and no longer resemble an infant industry. In 2002, undistributed credit union profits surpassed $5.6 billion.

As states address their fiscal problems, they are looking to broaden their tax base by closing loopholes. This has included the potential taxation of state chartered credit unions.

However, the preservation of the federal credit unions’ tax exemption from state and local income taxes and sales taxes is a threat to the dual chartering system. If states tax their state chartered institutions, this creates an economic incentive for state chartered credit unions to flip to a federal charter. This effectively ties the hands of state legislators. In order to achieve parity with the federal charter, state governments maintain the tax exemption for the state chartered credit unions.

The elimination of the federal prohibition on states taxing federal credit unions is necessary to preserve the dual chartering system.

¹ The Federal Credit Union Act (12 USC 1768) exempts federal credit unions from taxes "imposed by the United States or by any State, Territorial, or local taxing authority except that any real property and any tangible personal property of Federal credit unions shall be subject to Federal , State, Territorial and local taxation to the same extent as other similar property is taxed.

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