Background
Section 122 of the Federal Credit Union Act (12 U.S.C. § 1768) states that credit unions are exempt from all taxes except for local real property and personal property taxes (see NCUA Letter of Exemption):
The Federal credit unions organized hereunder, their property, their franchises, capital, reserves, surpluses, and other funds, and their income shall be exempt from all taxation now or hereafter imposed by the United States or by any State, Territorial, or local taxing authority; except that any real property and any tangible personal property of such Federal credit unions shall be subject to Federal, State, Territorial, and local taxation to the same extent as other similar property is taxed.
While the Federal Credit Union Act does not specifically explain why credit unions receive a tax exemption, various government actions and documents have provided commentary on the subject. A 1979 Internal Revenue Service (IRS) document explains that IRC 501(c)(14) exempts credit unions that are operating on a not-for-profit basis, organized without capital stock, and operating for mutual purposes. Furthermore, federally chartered credit unions are considered to be instrumentalities of the United States and are exempt under 501(c)(1). The IRS document suggests that credit unions merit a tax exemption as they have certain features that clearly distinguish them from other financial institutions and have not deviated from their original purpose. For example, credit unions still have a common bond among members and serve as a source of credit for low- and moderate-income people.
In 1998, as part of the findings of the Credit Union Membership Access Act, Congress found that:
Credit unions, unlike many other participants in the financial services market, are exempt from Federal and most State taxes because they are member owned, democratically operated, not for profit organizations, generally managed by a volunteer Board of Directors, and because they have the specified mission of meeting the credit and savings needs of consumers, especially persons of modest means.
Still, credit unions do pay many taxes and fees, among them payroll and property taxes. It is also important to note that share dividends paid to credit union members are taxed at the membership level. Critics argue that credit unions today are no different than banks. However, the defining characteristics of a credit union, no matter what the size, remain the same today as they did when the Federal Credit Union Act became law in 1934: credit unions are not-for-profit cooperatives that serve defined fields of membership, generally have volunteer boards and cannot issue capital stock. Credit unions are restricted in where they can invest their members' deposits and are subject to stringent capital requirements. A credit union's shareholders are its members and each member has one vote, regardless of the amount on deposit. Credit unions are fundamentally different than banks, and their tax exemption is a reflection of that indisputable fact.