New Judge Ruling Positive for SCUs in Challenge to UBIT Brought by Bellco CU

April 6, 2010 — In the latest challenge to unrelated business income tax (UBIT), a federal judge determines income from credit life and disability insurance and royalties from accidental death and dismemberment (AD&D) should not be subject to UBIT.

In 2008, Bellco Credit Union (Greenwood Village, Colo.) requested a refund of nearly $200,000 on income from UBIT paid during the 2000, 2001 and 2003 tax years on the sale of credit life and disability insurance, AD&D insurance and income from a securities product. The lawsuit was supported by the UBIT Steering Committee, comprised of NASCUS, CUNA, CUNA Mutual and the Association of American Credit Union Leagues.

In the April 2 ruling, Judge Christine M. Arguello ruled credit insurance was substantially related to the credit union's tax-exempt purpose because it promotes thrift. "In the banking and credit context, the concept of thrift is tied to sound financial management," she wrote. "Credit insurance does just that. It permits a borrower to guard against certain difficult circumstances and to know that, if the unfortunate event of death or a serious disability occurs, the borrower's family and/or assets would be protected. For a relatively marginal payment, the borrower buys peace of mind."

Judge Arguello also agreed with Bellco that its AD&D income, from a third-party vendor's sale of AD&D insurance to Bellco members, constituted royalties that are exempt from UBIT. While Bellco did perform some work in connection with the AD&D program, the court disagreed with IRS's claim that the revenue should be taxed and determined the work was sufficiently insubstantial for the income to appropriately be deemed as royalties.

Prior to the December 2009 trial, Judge Arguello issued a summary judgment stating that income from the sale of financial products (such as stocks and annuities) to Bellco members was not subject to UBIT. Conversely, the court also determined that the sale of financial products by investment representatives in Bellco branches to non-members was not substantially related to Bellco's tax-exempt purpose and therefore subject to UBIT.

There are two elements of the April 2 ruling that are against Bellco, stemming from recordkeeping issues, such as one largely related to a credit union that merged into Bellco, rather than the principles that were the focus of the case. The IRS could appeal the April 2 ruling, but there is no indication of when and if that might happen. NASCUS will keep you posted of developments.

NASCUS appreciates Bellco Credit Union and its leadership for their willingness to challenge the IRS' application of UBIT. This is the second litigation effort to challenge UBIT. Community First Credit Union, Appleton, Wisc., went to trial against the IRS in May 2009. The jury in that case favored the credit union determining that the sale of credit life and credit disability insurance and guaranteed auto protection (GAP) are related to the mission and purpose of the credit union and therefore are not taxable.