On March 5, the Internal Revenue Service released a ruling stating that certain products offered by state-chartered credit unions fall outside a credit union’s core purpose and therefore taxes could be collected on revenue generated from these sources. Such products labeled by the IRS include insurance products like accidental death and dismemberment, dental, and disability. Other products listed were car-buying services and the sale of car warrantees. The reasoning of the IRS was that these products were not related to credit unions’ core mission of promoting thrift and providing low cost credit to members.
Non-Interest Income Across Financial Institutions
Products such as these provide members greater financial protection as well as an important source of income for credit unions. Non-interest income is particularly important to credit unions today due to tighter interest rate margins. The income is needed to ensure credit unions’ business model continues to provide for investments in new products and services, as well as competitive rates for members.
Banks are facing similar challenges with today’s interest rate environment. According to a recent issue of American Banker, smaller community banks are beginning to have to look for new sources of non-interest income to continue to drive bottom line growth and appease shareholders. Some examples of this include banks becoming more involved in the personal investment area, such as mutual funds and one bank even created a travel agency.
How Much Income Is At Stake?
In 2006, non-interest income represented 2.1% of assets for all U.S. banks. For credit unions, non-interest income represented 1.2%. In dollar terms, non-interest income totaled $240.7 billion for banks and just over $9.0 billion for credit unions.
According to results from Callahan’s Non-Interest Income Survey, interchange income from debit and credit card transactions continues to be the largest source of this income stream, comprising 36% of non-interest income as of June 2006. Income from insurance sales comprised 5% of non-interest income. So, while not a major source of non-interest income, it is material at approximately $450 million in 2006. State-chartered credit unions generate about 45 percent of non-interest income across the industry. Using a 25% federal tax rate, net revenue at these credit unions could be reduced by over $50 million. While this represents only a fraction of total credit union revenue, it would be that much less available to reinvest in member value.
While trade associations work to challenge this ruling it is important for credit unions, both state and federally chartered, to be aware of this decision. Although the outcome and full potential impact are uncertain, it is not too early to start thinking about how to mitigate any ramifications in credit unions’ ability to deliver member value.