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The simple answer is—they do not escape taxation. Taxes are deferred. When reserves are eventually distributed to individual members for their benefit, they’re taxed.
This is similar to a 401k.
Perhaps it can be agreed that no one wants to pay taxes on something they have no access to or have not received. Income taxes are generally not levied on a future event or future receipt of income.
Because no individual member of the credit union can access or gain personal advantage of the retained earnings, no income tax is accessed against those earnings.
As a result, in a manner like many retirement accounts, retained earnings are allowed to accumulate tax-free until they are distributed to the members, at which time all applicable income taxes are paid.
If a credit union closes its doors for good, and dissolves, the entire amount of retained earnings are distributed as dividends to the members. The member pays taxes on those dividends.
Sometimes when two credit unions merge, a portion of the retained earnings are distributed back to members prior to the merger. Members who receive those dividends must pay taxes on them.
For credit union retained earnings, there is no permanent escape from the taxman. No one, no group, is getting anything for free because of the credit union tax exemption.
Credit union’s income tax exemption was debated by the House on November 24, 1937 and recorded in the Congressional Record. Senate Bill 2675 was the bill to amend the Federal Credit Union Act. In the process of passing the bill, Rep. Robert Luce, R-Mass, said, “The system has no element of profit making whatever.”
