Judge Christine M. Arguello has issued her decision in Bellco Credit Union versus the United States of America. This is one of the UBIT cases. The IRS assessed Bellco Unrelated Business Income Tax (“UBIT”) on certain income items and Bellco paid the tax and has sued for a refund. By doing so, Bellco is able to have this case litigated in federal district court and not the tax courts which tend to be more favorable to the IRS.

The taxes were assessed upon the following types of income:

1. Financial Services such as networking fees paid by an affiliated broker/dealer;
2. Credit Life and Credit Disability Insurance (collectively “Credit Insurance”); and
3. Accidental Death and Dismemberment Insurance (“AD&D”).

The taxpayer, Bellco, has the burden of proof to show that the income was not subject to the Unrelated Business Income Tax. On some points Bellco lost due to inadequate records. Bellco often had to reconstruct records over many years as the UBIT issue was not a consideration at the time some of these services were provided.

The Court focused on whether the income was substantially related to one of the two purposes of Bellco which the IRS agreed is to promote thrift among the members (“thrift function”) and to provide a source of credit upon reasonable terms (“lending function”). The Court also looked to see if the payments were royalties as royalties are not subject to UBIT.

The first decision in the case was on November 12, 2009. The Judge decided the following on a Summary Judgment Motion:

1. Bellco has a networking agreement with CUSO Financial Services, LP (“CFS”) wherein CFS provides non-deposit financial products to enable members to plan and invest in their future. The Court concluded that this meets the thrift function and therefore all the networking fees derived from the services to members are not subject to UBIT. Any networking fees derived from services to non-members is subject to UBIT.

2. Bellco is a co-owner of Member Gateways, LLC. Member Gateways is a co-owner of CFS. While some of the profits from CFS and other sources are filtered to Bellco through the Member Gateways relationship, Bellco did not prove the substantial connection to the thrift function and therefore the income from Member Gateways is subject to UBIT.

3. First Choice Credit Union merged into Bellco. Since Bellco could not establish some of the sources of the income that came over to Bellco, that income is subject to UBIT.

The second decision was issued on Good Friday April 2, 2010. The Judge decided the following after a trial:

1. Bellco has a Credit Insurance Plan for direct and indirect lending programs that pays off the balance of a loan should a member die or is disabled during the term of the loan. This product is the source of the famous credit union slogan, “The debt dies with the member.” The testimony established that Bellco ran a good program that gave good value for the services and was not primarily profit driven. The Court found the Credit Insurance products promoted thrift as a valuable part of a member’s financial planning and therefore the income derived by Bellco on these products was not subject to UBIT. There was certain undefined Credit Insurance income which did not have adequate records to establish the source of that income and so it was subject to UBIT. Finally, Bellco is a co-owner of CUILA, an indirect lending CUSO. There were not sufficient records to establish that the source of the income was Credit Insurance and so it was subject to UBIT.

2. The income from the AD&D products was deemed a royalty and not subject to UBIT. The testimony showed that the only function of Bellco was to manage its brand, e.g., checking to see that advertisements were not offensive to the members. All substantive work was being done by AD&D providers in a turn-key operation.

Conclusion

This was a great victory for Bellco and credit unions. If a credit union can tie the income to a thrift function or royalty, the income derived from the activity will not be subject to UBIT. This was true for networking fees from investment services, credit life and credit disability as long as the credit union is not primarily driven by profits and AD&D. While the IRS can appeal, this case and the Wisconsin case are two big victories.