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On Friday night, December 1, 2017, the Senate passed the “Tax Cuts and Jobs Act”, which would cut taxes by roughly $1.5 trillion over ten years and would make significant changes to and simplify our nation’s tax laws. The full House of Representatives passed its tax reform bill last month. Now negotiators from both chambers will meet in earnest to craft a compromise bill that can pass both bodies before the end of the year.
Both the House and Senate bills would not alter or eliminate the credit union federal income tax status in any way! This is a huge victory for the credit union movement and an affirmation by the United States Congress of the value proposition of the credit union difference. This was accomplished against the unified opposition and lobbying force of America’s banks and their $17 trillion in assets!
The House has already selected members to serve on the House and Senate tax reform conference committee. We expect the Senate to follow suit in short order. CUNA and its system partners will continue fierce advocacy in promotion of tax policies that benefit credit unions and equally fierce opposition to tax provisions that hinder the ability of credit unions to serve their members. With that said, we expect a major tax reform bill to be enacted into law by the end of this year.
While many other credits, deductions and tax expenditures would be eliminated or scaled back by these two bills, neither one makes any change to the federal tax exemption for state and federally chartered credit unions. We attribute the preservation of the credit union tax status to an understanding on the part of tax writers that credit unions continue to fulfill their statutory mission to promote thrift and provide access to credit for provident purposes through a cooperative, not-for-profit, structure.
In 2016, credit unions provided total member benefits equal to $10.2 billion. In addition, bank customers saved about $4 billion in 2016 from more favorable pricing due to the presence of credit unions in their local markets. These bills are indeed an affirmation of the good work and positive impact that credit unions make in the communities they serve.
All credit unions are exempt from the federal corporate income tax under §501(c)(1) of the Internal Revenue Code for federally-chartered credit unions and under §501(c)(14)(A) for state-chartered credit unions. Nevertheless, income at state-chartered credit unions that the Internal Revenue Service (IRS) deems to be unrelated to the credit union’s tax-exempt purpose is subject to taxation under §511-513; federal credit unions are not subject to UBIT requirements because they are instrumentalities of the federal government and subject to restrictions on activities imposed by Congress.
Income that is subject to UBIT is defined as any net income derived from any “unrelated trade or business” – defined as “activity not substantially related to organization’s exempt purpose.” Income is “substantially related” if it “contributes importantly to accomplishment of the organization’s exempt purposes.” UBIT was designed to prevent unfair market competition from tax-exempt entities against for-profit entities.
The IRS requires that state-chartered credit unions file annual Form 990s, like most other tax-exempt entities. These credit unions must also file a Form 990-T (UBIT Form) if the tax-exempt entity has unrelated business taxable income to report.
The House bill would require tax-exempt organizations (including state-chartered credit unions) to pay UBIT on certain employee fringe benefits, namely transportation and parking benefits, as well as on-site gyms and athletic facilities. In this legislation, any taxpaying entity is no longer allowed to deduct these same employee benefits. The bill places this new burden on exempt organizations and shall apply to amounts paid or incurred after December 31, 2017.
The original Senate bill included provisions that would have imposed a new Unrelated Business Income Tax (UBIT) requirement on credit unions and the trade associations like those that represent credit unions. This provision would have imposed UBIT on logo and royalty income that many credit unions and others depend upon … income that in reality is in direct relation to their exempt status. CUNA opposition resulted in this provision being eliminated from the Senate-passed bill.
There are other provisions addressing not-for-profit entities in both the House and Senate bills. The legal language, as well as the lawmaker intent, are unclear at this time.
Both the House and Senate bills would impose an excise tax on certain executive compensation provided by tax-exempt organizations. Tax-exempt entities would be required to pay a 20% excise tax on the first five employees’ compensation that individually exceed $1 million annually. The definition of compensation includes cash and the cash value of most benefits. In both bills, the definition includes excess “parachute payments” that are currently valued at three times or more of the employee’s base compensation. In the House bill, payments to a tax-qualified retirement plans are not included in the definition of compensation. The Senate bill is unclear on this matter.
The excise tax would be paid by the employer on amounts that exceed $1 million annually and would be effective for tax years beginning after 2017. This provision is designed to create parity with respect to for-profit entities that can only deduct the first $1 million of each individual employee’s compensation.
The original Senate bill included a provision that would have modified the application of taxation on excess benefit transactions (intermediate sanctions) on certain employees at tax-exempt entities. The original bill would have expanded on current law by adding a 10 percent excise tax to the employer for each employee subject to the excise tax. CUNA opposition helped in this provision’s removal from the bill.
Early tax reform discussions on Capitol Hill included consideration of significant rollbacks in the availability of pre-tax contributions to these retirement plans to raise revenues in the legislation. Massive pushback from many sectors convinced Congress to back off such limits. Both House and Senate tax bills would make minor changes around the edges of these savings products but would not make substantive changes that would adversely affect Americans saving for retirement. Therefore, credit unions could expect continued demand for IRAs on their balance sheets and off-balance sheet investment services.
As part of fulfilling the credit union mission, many credit unions originate mortgages, refinance mortgages, and provide home equity loans to their members. During early tax reform discussions, tax writers considered eliminating the mortgage interest deduction and the property tax deduction for homeowners in order to help "payfor” other tax cuts. Ultimately, the Senate and House decided to primarily expand on existing limitations on these deductions.
The Senate decided to preserve the home mortgage interest deduction for existing and new mortgages so mortgage holders would continue to be able to deduct the interest on the portion of their principal residences that are valued at less than $1 million. However, interest on home equity loans would no longer be a deductible expense.
The House also voted to preserve the home mortgage interest deduction for existing mortgages so existing mortgage holders would continue to be able to deduct the interest on the portion of their principal residences that are valued at less than $1 million. However, interest on existing home equity loans incurred before November 2, 2017, of up to $100,000, would continue to be deductible. But, for new homes bought after November 2, 2017, only the interest on the mortgage amount of up to $500,000 would be deductible. Further, this deduction would be available on only one principal residence.
With respect to the refinancing of mortgages, if the home debt was incurred prior to November 2, 2017, the House bill states that the refinanced product would be treated as incurred on the same date that the original debt was incurred for the purposes of determining the amount of interest allowed to be deducted.
The deductibility of state and local property taxes also effects the attractiveness and affordability of home mortgage products offered by credit unions. In both the House and final Senate bills, individual taxpayers would be able to deduct no more than $10,000 in personal (nonbusiness) property taxes on the itemized portion of their tax returns. This provision would be effective for tax years beginning after December 31, 2017. This may slightly retard long-term home price appreciation.
It is important to note that the deduction of mortgage interest and property taxes, along with other deductions like charitable contributions, are only attractive insofar as one’s deductions exceed the amount of the standard deduction. Both bills would nearly double the standard deduction. If enacted into law, even those with average sized mortgages might choose the standard deduction in lieu of itemizing the home interest they have paid, depending on whether their itemized deductions will lower their tax bill more than simply taking the new doubled standard deduction. On the other hand, existing tax law has a provision referred to as the “Pease” limitation, which limits itemized deductions for wealthier taxpayers. The House and Senate bills would eliminate this limitation.
The House tax bill eliminates the new markets tax credit. This credit is important to the Community Development Financial Institutions (CDFI) community. Under this section, no additional new markets tax credits would be allocated after 2017 but credits that would have already been allocated may be used for seven years. The CDFI Fund administers the New Markets Tax Credit program, which provides tax credits to Community Development Entities (CDEs), which in turn provide the tax credits to entities which invest in the CDEs.
The Senate bill, on the other hand, does not eliminate the New Markets Tax Credit.
Both final House and Senate tax bills were passed with previous deferred compensation restrictions removed.
Credit unions play a key role in helping solve the credit crunch facing America’s small businesses. When other lenders have been forced to pull back lines of credit, credit unions have continued to lend and they have the capacity to do more. Unfortunately, credit unions are unnecessarily restricted from similarly alleviating the credit crunch that grips America’s small businesses by an arbitrary statutory cap on business lending of 12.25% of a credit union’s total assets. Credit unions have been subject to this statutory cap for nearly 20 years. However, there is no economic or safety and soundness rationale for this cap. Prior to 1998, there was no business lending cap. Credit unions have a long history of offering their members loans to help start small businesses. In fact, credit unions have been offering business loans to their members since their inception. The average credit union business loan is approximately $200,000; this means that credit union business loans are used not only to start new businesses but also help credit union members make payroll, stay in business, expand their businesses and stimulate the economy. Part of making these small member business loans attractive for credit union members is the federal tax deductibility of the interest on these loans.
Both tax bills would preserve the deductibility of interest on smaller business loans, like the ones credit unions make. In general, small businesses with average annual gross receipts of less than $15 million (Senate bill) and $25 million (House bill) would be exempt from new interest deductibility rules. This provision would be effective for tax years beginning after 2017.
Both House and Senate tax legislation would affect credit union members in various ways by three major changes: reductions in tax rates, a near doubling of the standard deduction, and elimination or curtailment of many itemized deductions and credits. The tax rate reductions for income levels of most credit union members would provide significant decreases in total tax bills. Both pieces of legislation would also reduce the attractiveness of itemizing deductions for many credit union members. Some of the itemized deduction changes which would directly affect members’ use of credit unions, are discussed in more detail below.
The net income increases that most households will enjoy from this legislation, after a long period of real wage stagnation, would likely make a difference in many households’ spending plans. Some of that spending will likely involve increased consumer loan demand at credit unions.
Both the House and Senate bills would sharply reduce itemized deductions by middle-income households. This is due both to the doubling of the standard deduction and elimination or reductions of deductions. According to the Tax Policy Institute, under current rules less than half of tax filers with annual incomes under $100,000 itemize, while the vast majority of those with higher incomes do so. If any version of existing tax legislation is enacted in its current form, fewer taxpayers with incomes below $100,000 would itemize, and many with incomes between $100,000 and $150,000 would likely find it no longer worthwhile. That encompasses the vast majority of credit union members.
Proponents of the House and Senate legislation suggest that tax simplification and reductions would spur economic activity. That is very likely to happen, but the size of the effect is subject to debate. There would also be some dislocations as sectors whose tax preferences are reduced grow more slowly and other industries enjoy faster growth due to tax rate reductions. The net effect would likely be to strengthen the current economic expansion and delay the next recession. Of course, both bills would also increase the national debt over the next decade. Faster growth would recover some of the $1.5 trillion.
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