Should the Earnings of Credit Unions That Convert to Banks be Taxed?

Credit Union Times   May 24, 2006
By David Morrison

WASHINGTON - Should credit unions that convert to mutual banks and then go on to issue stock pay taxes on the retained earning they bring with them? Or should the retained earnings be channeled into an independent foundation or other charitable organization dedicated to fulfilling some of the credit union's original purposes? The question did not originate with Representative Paul Kanjorski (D-Penn.), but the longtime legislative friend of credit unions gets the credit for bringing it out loud and clear into the public policy debate. Addressing a mixed panel of credit union-to-bank conversion opponents and proponents at a recent Congressional hearing, Kanjorski seized on the idea and would not easily be shaken from it. Since credit unions receive their tax-exemption in part because they serve a special purpose, why can't society recoup those unpaid back taxes, Kanjorski asked, particularly if the credit union is converting to another type of institution that does not have that purpose? " Overall, I think it's an idea that definitely needs study," said Paul Hazen, CEO of the National Cooperative Business Association, an association of all types of cooperative businesses which serves as a center of expertise about cooperative business issues.

Hazen and other cooperative business leaders point out that credit union-to-bank conversions are unique among similar conversions, not only in the U.S., but worldwide, in that they are one of the only ones in which money from the converting nonprofit either passes on to the for-profit succeeding firm or to insiders and the public at large as a stock offering. In almost every other industrialized country, when a nonprofit cooperative fails or is bought out, the current participants receive back what they put into it, plus a reasonable amount of return on their investment, Hazen explained. Then, after all the liabilities are paid, whatever is left goes to another organization or to found another organization which will do similar work, he added.

"The analogy is if you have an organization which is dedicated to curing polio," Hazen said, "and polio is cured, any money left over after all the bills are paid will go to an organization that is dedicated to curing another disease and not to the public at large or leaders of the organization," he added.

Other proponents of the notion of communities or the credit union industry holding onto the retained earnings of converting credit unions point out that the principle is enshrined in the U.S. tax code as well.

"When a 501(c)(3) nonprofit organization files for nonprofit status, its bylaws have to contain a provision for what happens to the assets of the organization should it fold and those assets most often go to similar organizations," noted Randy Chambers, the CFO of the $243 million Self Help FCU and an organizer of the Center For Member Trust. "I think it's entirely appropriate that we begin to look at what happens with the retained earnings of converted credit unions."

The biggest precedent for communities maintaining control of the retained earnings of converting credit unions may be the health care industry, which has had its share of conversions of nonprofit health care plans to for-profit insurers.

According to Consumers Union, there are currently 64 health plans licensed by the Blue Cross, Blue Shield Association - 34 nonprofit, 16 mutual and 14 for-profit. The conversions of the nonprofit health plans into for-profit corporations have provided some of the best models for what can be done with money originally made as part of a nonprofit effort in one area and which is retained after a conversion, according to Laurie Sobel, lead attorney for the Consumers Union's Community Health Assets Project.

Sobel points to the creation of the California Endowment for Health, a $3.5 billion foundation established in 1996, when the nonprofit Blue Cross of California converted to the for-profit Wellpoint Health Networks. Since then the foundation, which is run independently, has granted more than $1.4 billion in grants to over 7,000 California organizations.

"The health plans built up their reserves free of taxes because they served a public good, Foundations like the endowment help make sure work is still being done to attain that public good even though the original organization has become a for-profit company," Sobel said.

One of the biggest stumbling blocks for the idea might be what to do with retained earnings that a converting credit union would have to leave behind as it became a nonprofit. In his remarks, Kanjorski appeared to favor simply taxing the money, reflecting the simple symmetry of having the government collect back taxes on money that it had refrained from taxing while the CU was organized as a CU. Interestingly, this point of view resonated as well with at least one banker in the country. In a letter in the ABA Banking Journal's May issue, James Lavoie, CEO of Middlesex Savings Bank, took issue with the Journal's April cover story on two credit unions in Texas, Community Credit Union and OmniAmerican Credit Union, which converted to mutual banks in 2005.

Community Credit Union, now Viewpoint Bank, has already filed its paperwork for the initial offering of stock under an MHC.

"This will result in the management and other insiders getting very rich quick," Lavoie wrote. "All at the expense of the American taxpayer who allowed them to build up capital over many years while paying no taxes. Those retained earnings (almost half of which should have gone to federal and state taxes) will eventually end up in their pockets. Pretty nice end game. They should have to pay back taxes to convert," Lavoie wrote.

But Hazen and Bucky Sebastian, CEO of the $880 million GTE FCU and chief organizer of the NCMT, don't tend to favor taxation and would rather see the money go to a foundation (Hazen) or simply be returned to the members (Sebastian) even though that would mean acknowledging that the current group of members would enjoy the benefits of money built up by previous generations.

Sebastian indicated that he had no firm opinion on what to do with the retained earnings of converting credit unions except that he knew what not to do with them. "I might not know what to do with money, but I know what not to do with it and that's to pass it on to line the pockets of people who have no claim on it," he said.

Interestingly, the idea is new enough that none of the mainstream proponents of conversion were willing yet to discuss it for the record. The only one who would, in a limited way, was Keith Leggett, senior economist with the American Bankers Association, who commented like the others that he had not studied the question sufficiently to answer questions about it, but who allowed that its chief negative might be its disincentive to conversions. "The impact of what will be perceived as a negative tax policy can be phenomenal," he said. Kanjorski's office did not return calls for additional comment as of press time.

© 2007, Used with permission from The Credit Union Times. All rights reserved.

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