If A Tree Falls In A Forest, Can It Be Taxed?

Credit unions don't want to lose their tax exemption, but does the movement take the time to explain member-ownership? And why it matters?

A story published recently in the Des Moines Register has the industry talking about taxation again. The Iowa Bankers Association has launched an ad campaign that argues the real difference between banks and credit unions is that credit unions are free-loaders that don’t pay taxes.

Same story, different day, state, and tax reform season.

There is widespread ignorance of the differences between credit unions and banks. Bankers take advantage of this. But what is the role of credit unions in this ignorance? Credit unions don’t want to lose their tax exemption, but does the movement take the time to explain member-ownership? And why it matters?ContentMiddleAd

Cooperative ownership is directly related to the logic of taxation. For-profit companies are in the business of generating income for their stockholders. It is this income that is taxed. Cooperatives do not generate income for their owners. Period. In the simplest terms, then, there is nothing to tax.

If a tree falls in a forest and no one is there to hear it, does it make a sound? It creates sound waves but sound as humans understand it is what we absorb through our ears. So without a listener, a falling tree does not make sound.

If a financial cooperative generates positive net revenue and no individual gets to spend it, is it profit? Not in the logic of taxes. Income taxes are levied on economic value that accrues, at least eventually, to an individual. Ultimately, this is the logic behind virtually every provision or exception in the income tax code.

Unhappily, in a world of willful misunderstanding and misrepresentation a world created by bankers’ associations credit unions don’t tell this story effectively.

The positive net revenue of credit unions does not accrue to credit union owners … so it should not be considered a taxable profit.

Chris Howard, SVP, Callahan & Associates

The positive net revenue of banks is taxed because it accrues to bank owners directly as stock dividends or indirectly as an increase in stock value. In other words, these are taxable profits because they represent economic value for individual owners.

The positive net revenue of credit unions does not accrue to credit union owners. Credit union owners do not receive stock dividends and the value of their ownership share can never increase. In other words, this positive net revenue does not represent economic value for individual owners, so it should not be considered a taxable profit.

This analysis does present some challenges, but even as they are teased out, the basic logic remains.

First, cooperatives are plagued by the language of the for-profit world. Credit unions have income statements and routinely speak in terms of income and profitability even though they use these words in ways differently from banks. This complicates the technical argument against taxation because there is no straightforward language to differentiate the positive bottom line of a cooperative from that of a for-profit company.

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Second, credit union owners do receive dividends, some of which appear remarkably similar to stock dividends. The key point here, though, is that all dividends, from any source, are taxable income to their recipients. In this sense, credit unions are taxed much as S Corporations are their owners are taxed on the economic value they receive.

Third, the complication of the S Corp comparison is the treatment of retained earnings. Stock owners can turn retained earnings into cash by selling their stock, so those earnings represent real economic value. Credit union owners cannot turn retained earnings into cash, so those earnings do not represent real economic value. In other words, credit unions really don’t have anything that should be taxed.

This is truth. We need to find an effective way to tell it.

This article appeared originally in the Credit Union Times in February 2018.

February 12, 2018

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