Explaining Why Credit Unions Are Tax Exempt

Credit unions are financial institutions that offer a range of services, including savings accounts, loans, and checking accounts, similar to commercial banks. They serve as a cooperative alternative within the financial industry, providing essential financial tools to their members.

The Cooperative Structure

Credit unions are distinct in their structure as they are member-owned, not-for-profit financial cooperatives. This means that individuals who use the credit union’s services are also its owners, rather than external shareholders. This ownership model ensures that the primary goal of a credit union is to serve its members’ financial well-being, not to generate profits for investors.

Members typically have democratic control, often exercising voting rights on important issues, such as electing the volunteer board of directors. This “one member, one vote” principle applies regardless of the amount of money an individual has within the credit union.

Any surplus earnings generated by a credit union are reinvested back into the institution to benefit its members. This reinvestment can manifest as lower loan rates, higher savings rates, reduced fees, or improved services. This operational model contrasts with institutions that distribute earnings to shareholders.

Applying the Tax Exemption

Credit unions receive a federal income tax exemption due to their cooperative, not-for-profit structure. This exemption falls under Internal Revenue Code Section 501 for state-chartered credit unions, and for federal credit unions as instrumentalities of the U.S. government. This tax status has been in place since the Federal Credit Union Act of 1934.

While exempt from federal income tax on their earnings, credit unions are not exempt from all forms of taxation. They are still responsible for paying various other taxes, such as property taxes, payroll taxes, and sales taxes. Additionally, any dividends or interest earned by members from their credit union accounts are subject to personal income tax.

This tax exemption allows credit unions to operate with a different financial model compared to for-profit entities. By not incurring corporate income tax liabilities, they can pass on financial benefits directly to their members. This enables them to offer more favorable terms, such as lower interest rates on loans and higher interest rates on savings products.

How Credit Unions Differ from Banks

The fundamental differences between credit unions and traditional commercial banks stem from their ownership structures and core missions. Commercial banks are typically for-profit corporations owned by shareholders, whose primary goal is to maximize returns for those investors. This profit motive influences their operational decisions, including fee structures and interest rates.

In contrast, credit unions operate with a member-centric mission, focusing on serving the financial needs of their members rather than generating shareholder profits. Banks aim to generate and distribute profits to their shareholders, and these profits are subject to corporate income tax.

The cooperative structure and tax exemption enable credit unions to offer more advantageous financial terms. They generally provide lower loan rates, higher savings rates, and fewer or lower fees compared to many banks. This is because credit unions reinvest any operational surplus back into member benefits, whereas banks must allocate profits to shareholder dividends and corporate tax liabilities.