Credit Unions, Taxes, and Dishonest Bankers

Credit unions are treated under the Internal Revenue Code as a not-for-profit entity. While that means that they do not face taxation at the entity level (as most–but not all–banks do), it does mean they are obligated to plow their earnings right back into their customers’ (“members’”) pockets. How does that work? Suppose you have a savings account at a credit union using retail bank software. The interest you earn on that savings is higher than an equivalent account you earn at a bank. That’s because the credit union has to give any profits back to their members, and in this case that means a higher interest rate on deposits.

Let’s take the other end of the retail banking software spectrum. You have a mortgage from a credit union. The interest you pay on that loan is lower than an equivalent mortgage you could obtain from a bank. That’s because the credit union has to give any profits back to their sme banking system, and in this case that means a lower mortgage interest rate. Well, there’s a tax cost to the credit union member for that treatment. In the case of our saver, he will have to report the higher amount of interest he earns on his tax return. In the case of our borrower, she will have that much less mortgage interest to deduct on her tax return.

Credit unions don’t pay taxes at the entity level because their customers end up doing that for them. Credit unions are best thought of as a pass-through firm in this way, like an LLC or an S-corporation. Banks simply have the inverse software asset management. They pay taxes at the entity level (or their shareholders do in the case of an S-corp bank), but their customers pay lower taxes than they would if they did their business at the credit.

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