The Taxman Cometh
Taxes – while necessary to our society, basically everyone hates paying them. Some credit unions recently received word from the Internal Revenue Service (IRS) that their tax liability may be greater this year due to some confusion over a tax credit from several years ago. Let’s journey back through time to view how this issue has evolved:
Back at the beginning of the COVID-19 pandemic, many areas went into lockdown and certain businesses were forced to close their doors. To respond to the economic shock of the pandemic, Congress passed the CARES Act. Section 2301 of the CARES Act provided an “employee retention credit for employers subject to closure due to COVID-19.” Under the law, eligible employers whose business operations were fully or partially suspended due to orders from an appropriate governmental authority could receive a credit for “equal to 50 percent of the qualified wages with respect to each employee” for each applicable calendar quarter. Some credit unions may have claimed this tax credit for wages paid during the 2020 calendar year.
However, the CARES Act was written to exclude certain employers from qualifying for the credit. The law states that the credit is not available to “the Government of the United States, the government of any State or political subdivision thereof, or any agency or instrumentality of any of the foregoing” (emphasis added). Thus, whether a credit union is an instrumentality of the U.S. government became an important determination when considering if the credit union could utilize the 2020 employee retention credit. In March 2021, the IRS issued this guidance, which provided six factors to consider when determining if an employer is an “instrumentality”:
- “whether the organization is used for a governmental purpose and performs a governmental function;
- whether performance of the organization’s function is on behalf of one or more States or political subdivisions;
- whether there are any private interests involved, or whether the States or political subdivisions involved have the powers and interests of an owner;
- whether control and supervision of the organization is vested in a public authority or authorities;
- if express or implied statutory or other authority is necessary for the creation and/or use of such an instrumentality, and whether such authority exists; and
- the degree of financial autonomy and the source of its operating expenses.”
Recently, the IRS published this memorandum. While the memo notes that it “may not be used or cited as precedent,” it does offer a look at the IRS’ approach to this issue. The IRS explains:
“Each federal credit union organized under the Act, when requested by the Secretary of the Treasury, acts as a fiscal agent of the United States, and performs such services as the Secretary of the Treasury may require in connection with the collection of taxes and other obligations due the United States and the lending, borrowing, and repayment of money by the United States. To facilitate these purposes, the National Credit Union Administration Board furnishes to the Secretary of the Treasury the names and addresses of all federal credit unions with such other information as may be requested by the Secretary of the Treasury. Any federal credit union organized under the Act, when designated for that purpose by the Secretary of the Treasury, is a depository of public money, except receipts from customs, under such regulations that may be prescribed by the Secretary of the Treasury.
The organization certificates of federal credit unions organized under the Act must satisfy certain specific requirements provided by the Act and must be presented to the National Credit Union Administration Board for investigation and approval.
The National Credit Union Administration Board has authority to suspend or revoke the charters of federal credit unions organized under the Act or place them into involuntary liquidation.”
Finally, the IRS states:
“We conclude that federal credit unions are instrumentalities of the United States government under the factors enumerated in Rev. Rul. 57-128. In particular, federal credit unions are created by federal statute. They further governmental purposes by promoting the economic health of underserved populations. They perform governmental functions in that they act as fiscal agents and as depositories of public money, and they perform such services as the Secretary of the Treasury may require in connection with the collection of taxes and other obligations as well as lending, borrowing, and repayment of money by government. These functions are performed on behalf of the United States. Further, control and supervision of federal credit unions is vested in public authority…
In light of the foregoing, for wages paid after March 12, 2020, and before January 1, 2021, federal credit unions may not claim the employee retention credit.”
Thus, this non-precedential IRS memo concludes that FCUs were ineligible to receive the 2020 employee retention credit. The memo does not opine on whether state-chartered CUs would also be instrumentalities. FCUs that claimed this credit may want to consult with their legal counsel and/or accounting professional regarding how to address their tax liability if they have received a tax credit that they were later determined to be ineligible to receive.
While some FCUs may be unhappy about the memo’s conclusion that FCUs are instrumentalities of the U.S. government, that conclusion is not without precedent. For example, this Revenue Ruling from 1960 notes that the IRS had “held that Federal Credit Unions organized and operated in accordance with the Federal Credit Union Act are recognized as instrumentalities of the United States within the meaning of section 501(c)(1) of the Code” (emphasis added). As that quote alludes to, FCUs receive tax-exempt status through section 501(c)(1) of the Internal Revenue Code – however, that section states that it only applies to “[a]ny corporation organized under Act of Congress which is an instrumentality of the United States…” (emphasis added). Thus, being an instrumentality of the U.S. government is critical to FCUs receiving their federal tax exemption.
However, the 2020 employee retention credit is not the only credit authorized by Congress during the pandemic. In late 2020, Congress passed the Taxpayer Certainty and Disaster Relief Act of 2020 (Relief Act), which extended the employee retention credit for several months in 2021. This page from the IRS website compares the different tax credit provisions of the CARES Act, the Relief Act, and subsequent laws such as the American Rescue Plan Act. Notably, the Relief Act and subsequent laws expanded the credit so that it also applied to certain governmental employees, including those entities which are tax-exempt under section 501(a) and 501(c)(1) of the Internal Revenue Code. The IRS memo linked above concludes that these changes made the 2021 credits applicable to FCUs:
“For wages paid after December 31, 2020, and before July 1, 2021, federal credit unions may claim the employee retention credit. Although… the CARES Act… prohibits instrumentalities of the United States government from claiming the employee retention credit, section 2301(f)(2) of the CARES Act, as amended by the section 207 of the Relief Act, specifies that this prohibition does not apply to organizations described in section 501(c)(1) of the Code and exempt from tax under section 501(a) of the Code. Federal credit unions are such organizations.
For wages paid after June 30, 2021, and before October 1, 2021 (or in the case of wages paid by a federal credit union which is a recovery startup business, January 1, 2022), federal credit unions may claim the employee retention credit. Although section 3134(f)(1) of the Code prohibits instrumentalities of the United States government from claiming the employee retention credit, section 3134(f)(2) specifies that this prohibition does not apply to organizations described in section 501(c)(1) of the Code and exempt from tax under section 501(a) of the Code. Federal credit unions are such organizations.”
Thus, while the CARES Act was written in a way that may have excluded FCUs from eligibility for the 2020 employee retention credit, subsequent legislative changes made it so that FCUs could qualify for the credit for wages paid during the first nine months of 2021.
As mentioned above, credit unions may want to consult with their legal counsel when determining their applicability for credit under federal tax law and may want to review how this non-precedential IRS memo may affect their tax liability and strategy moving forward.
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About the Author
Nick St. John, was named Director of Regulatory Compliance in August 2022. In this role, Nick helps credit unions with a variety of compliance issues.