A credit Union makes loans exactly the same ways a bank does. A portion of the money deposited in checking, savings, money market, Certificate of Deposit, or IRA is then used to make loans for cars, boats, school, mortgages, 2nd mortgages, lines of credit...
The government dictates the percentage of each type of deposit that must be held in reserve for non-loan transactions.
The Credit Union members are the share holders of the "company". There are no investors in the "company" because the goal is not to make money. In general the entire package is better because there is no pressure to increase profits. Fees are generally lower because they are there to discourage bad behavior, not as a way to make a profit off of the bad behavior.
Dividends/interest are treated the same way as bank interest. The IRS forms are the same, and it is reported the same way.
Some of bizarre rules they have to follow: maximum number of transactions between accounts, membership rules, are there because banks want to make it harder to be a member of a credit union.