House Tax and Spending Bill Continues Income Tax Carveout for Credit Unions

The House taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. and spending bill, now headed to the Senate as part of the budget reconciliation process, could be improved in many ways. While it makes some progress closing loopholes, in the banking sector it leaves in place a long-standing provision that exempts credit unions from federal and state income tax, allowing them to compete unfairly with banks and, increasingly, to buy them. Rather than facing the problem head-on and repealing the credit union exemption, the bill pursues a misguided approach of tit-for-tat penalties on executive compensation for both credit unions and banks.

Like banks, credit unions take deposits and lend money, earning profits on the spread between interest rates on deposits and loans. Unlike banks, credit unions pay no tax on their net earnings. This special carveout has existed since the Great Depression, when lawmakers were concerned about banks charging excessive rates on loans to the poor and working class. Credit unions were intended to serve low- and middle-income households with a “common bond” or specific “field of membership,” such as a common employer, but over time lawmakers have relaxed the restrictions to allow credit unions to spread risks across larger numbers of depositors and borrowers, much like banks do.

As a result, credit unions now largely operate like tax-exempt banks, often competing for the same customers and providing many of the same services. Credit unions and banks both serve low- and middle-income households, with studies indicating a greater share of bank customers are at the lower end of the income scale.

The key difference is credit unions do not have to pay federal or state income tax or comply with income tax filing requirements.

Another unfair advantage federal credit unions have, even over other nonprofits, is that they are not required to transparently report on their finances or executive compensation, something typically required of other nonreligious nonprofits as part of their annual Form 990 federal tax return filing. Form 990s are publicly available, serving to hold nonprofits accountable to donors, members, and stakeholders. Federal credit unions are also exempt from unrelated business income tax (UBIT) rules that are meant to ensure nonprofits pay tax on income derived from commercial activities unrelated to the organization’s mission.

These tax benefits and other advantages have led to rapid growth for credit unions in recent years. As of 2024, credit union assets totaled $2.3 trillion, more than doubling since 2014 in nominal terms and up 54 percent after adjusting for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. . Meanwhile, total net income grew from $8.8 billion in 2014 to $14.4 billion in 2024, up 22 percent after adjusting for inflation. As restrictions on their membership and activities have been reduced, credit unions have consolidated their numbers and grown larger. The average credit union had $519 million in assets in 2024 versus $179 million in 2014, up 116 percent after adjusting for inflation. More than 400 credit unions have at least $1 billion of assets, and 20 have assets exceeding $10 billion.

Furthermore, credit unions are increasingly growing by buying banks. More than 100 credit union-bank acquisition deals have been announced since 2011, with a record 22 announced last year. More than 80 of the deals have been completed, while others fell through or were stopped by state regulators. Some states are pushing back in other ways, subjecting the new entities to additional tax or regulation, while other states are more supportive. Almost 40 percent of the deals have occurred in Alabama, Florida, and Michigan.

The problem is best addressed at the federal level by ending the credit union exemption, which could raise substantial revenue to offset the cost of the reconciliation bill or otherwise reduce deficits. Based on the latest tax expenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit (EITC), child tax credit (CTC), deduction for employer health-care contributions, and tax-advantaged savings plans. estimates from the Treasury Department, the credit union exemption is expected to reduce federal tax revenue by about $32 billion over the next decade (2025 to 2034). The Joint Committee on Taxation (JCT) finds the cost of the exemption is about 20 percent larger, based on tax expenditure estimates through 2028, indicating a cost over the next decade of about $39 billion.

While the House bill does not repeal the credit union exemption it does expand application of an existing excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. on executive compensation within tax-exempt organizations, including credit unions. Created as part of the 2017 Tax Cuts and Jobs Act (TCJA), Section 4960 requires tax-exempt organizations to pay a 21 percent excise tax on compensation above $1 million for covered employees, defined as the five highest-paid employees. Once a covered employee, always a covered employee, such that over time the tax can apply to more than five employees. The tax also applies to parachute payments, such as severance packages or lump-sum payouts, that are at least three times the employee’s average annual compensation over the previous five years (which can be less than $1 million).

Credit unions are subject to the excise tax on compensation, with some ability to plan around it. The House bill attempts to close down some planning opportunities by expanding the applicability to all current and former employees, not just the top five. JCT estimates the provision will raise $3.8 billion over the next decade, but most of this likely comes from tax-exempt hospitals and universities, which represent the largest tax-exempts.

A similar provision, Section 162(m), applies to publicly traded companies including banks, denying a deduction for executive compensation above $1 million, amounting to a top federal tax rate of 58 percent (21 percent corporate tax rate plus 37 percent top tax rate on individual income) for the CEO, CFO, and the next eight most highly compensated employees. The House bill also tightens these rules to include affiliated companies, raising about $15.7 billion over the next decade, according to JCT.

Targeting a select group of employees with a much higher tax rate than others is non-neutral, arbitrary, and full of potential loopholes. It requires an evolving set of rules defining components, timing, and sources of compensation that are difficult to administer and comply with. Burdening companies and tax-exempt organizations with these rules is a substantial compliance challenge that is likely not worth the revenue.

Lawmakers should rethink their approach, scrap the compensation penalties in Sections 162(m) and 4960, and instead identify which tax-exempt organizations deserve that distinction and which do not. Credit unions have grown large enough to buy other banks, cross state lines, and sponsor sports stadiums. As banks are required to pay income tax, so should credit unions.

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