Congress has been accused of accomplishing very little in 2012, but lawmakers did focus attention on Native American tax issues through several productive hearings. In addition, Internal Revenue Service guidance on Indian tribal tax issues reached an all-time high. This alert discusses 10 Indian tribal tax developments from last year and how they are likely to influence the priorities of tribal leaders, legal counsel, financial officers and government affairs representatives in 2013.
1. Fiscal Cliff Concerns: Impact of Expiring Tax Provisions and Rising Tax Rates
Facing the ire of public sentiment and Wall Street jitters, Congress and the Obama administration were finally able to pass The American Taxpayer Relief Act of 2012, which extended a variety of expiring tax provisions, including several tax provisions of particular interest to Indian Country. For example:
Now extended through the end of 2013 is the provision offering taxable business owners accelerated depreciation on depreciable property and infrastructure located on Indian reservation and trust land, which would have expired effective for property placed in service on or after January 1, 2012; also, the Indian employment credit and the New Markets Tax Credit.
The law permanently extends the Bush tax cut rates for most taxpayers, but it restores the 39.6 percent rate for high-income households (defined as single filers with incomes above $400,000 and married couples with incomes above $450,000). The agreement does not contain a provision to extend the employee payroll tax cut of 2 percent. As a result, all employees will now be subject to the full 6.2 percent rate on payroll taxes. Effective tax rates will also increase for taxpayers with incomes above $200,000 ($250,000 for married filers) due to the personal exemption phase out and partial phase-out of itemized deductions.
In addition to the rising tax rates on wages and other income, a new tax on the investment income of upper-income taxpayers will come into effect this year. The so-called 3.8 percent "Medicare tax" will affect such individuals with respect to their investment income (e.g., dividends, interests and capital gains), resulting in a combined top rate on such income of 23.8 percent (up from 15 percent). Per capita income from gaming is not defined as "investment income" for this purpose, but it will be taxable at the even higher rates of tax applicable to wage income and other form of "ordinary" income.
On January 3, 2013, the IRS released the new wage withholding tables (including timelines for catch-up withholding on payroll taxes). Click here and here for details on Notice 1036. As of January 7, 2013, the IRS still had not yet updated the special withholding tables in IRS Publication 15A applicable to per capita distributions of gaming revenues.
TO DO IN 2013: Tribal Chief Financial Officers (CFOs) will need to oversee the implementation of the new wage withholding rates (including for payroll taxes on all employees) and watch for the release of new IRS withholding rates applicable to per capita gaming distributions. Failure to adopt new withholding tables may subject the tribe to IRS penalties even if tribal members and/or employees ultimately pay the correct amount of tax on their returns filed the following year.
2. General Welfare Tax Planning in the Wake of IRS Guidance Offering Safe Harbors
On December 5, 2012, the IRS proposed administrative guidance on how it plans to apply the general welfare exclusion to tribal government programs. In response to a well-coordinated lobbying effort by several national and regional tribal organizations, the guidance establishes a safe harbor applicable to specific types of government programs under which the IRS will conclusively presume that the "individual need" requirement of the exclusion is met. The "need" requirement has been a major sticking point in a number of IRS audits of Indian tribes, particularly where the tribe provides the benefits to all members, and such members also receive per capita payments placing them above typical eligibility thresholds for government social welfare programs. Under another safe harbor, the IRS will conclusively presume that the "no compensation for services" requirement is meet if the program involves specific types of religious and cultural practices of the tribe. If a program or practice falls within a safe harbor, the tribe will not be required to issue a 1099 reporting the value of the benefit received by the tribal member as income.
In Notice 2012-75, the IRS outlined the requirements associated with the safe harbor under which the "need" prong of the general welfare requirement will be presumed to be met. This safe harbor requires that the program meet certain general criteria listed in Section 5.02(1) and be specifically described in Section 5.02(2) of the Notice. The general criteria in Section 5.02(1) include the following six requirements:
the benefit is provided pursuant to a specific Indian tribal government program
the program has written guidelines that specify how individuals may qualify for the benefit
the benefit is available to any tribal member who satisfies the program guidelines
the distribution of benefits from the program does not discriminate in favor of members of the governing body of the tribe
the benefit is not compensation for services
the benefit is not lavish or extravagant
The specific types of benefits described in Section 5.02(2) of the proposed Notice include benefits falling with five main categories:
Housing program benefits relating to principal residences that: (1) assist in making mortgage or rent payments for residences on or near a reservation; (2) enhance habitability of housing (such as by remedying water, sewage, sanitation services, or heating or cooling issues); (3) provide basic housing repairs or rehabilitation; or (4) assist in paying charges for utilities
Educational program benefitsto: (1) provide students (including post-secondary students) transportation to and from school, tutors and school supplies; (2) provide tuition payments and living expenses for students to attend various educational programs; or (3) provide job counseling, job training and other assistance to individuals seeking employment
Elder and disabled program benefitsfor individuals age 55 or older or who are disabled that provide: (1) meals; (2) home care or day care outside the home; (3) local transportation expenses; (4) travel expenses for doctor appointments or other medical care; (5) transportation costs and admission fees to attend educational, social or cultural programs offered by the tribe or another tribe; or (6) improvements to adapt housing to special needs.
Other qualifying assistance program benefitsto: (1) pay bus, taxi or public transportation fares from the Indian reservation to public facilities (such as medical facilities and grocery stores); (2) pay for the cost of transportation and temporary meals and lodging of a tribal member, spouse or dependent while the tribal member, spouse or dependent is receiving medical care away from home; (3) provide assistance to individuals in exigent circumstances (such as victims of abuse); (4) pay costs for temporary relocation and shelter for individuals displaced from their homes (due to fire or natural disaster); (5) provide emergency food, travel or lodging assistance to an individual who is stranded off the Indian reservation; or (6) provide or reimburse the cost of nonprescription drugs.
Cultural and religious program benefitsto: (1) pay or reimburse travel expenses (transportation, food, and lodging) to attend an Indian tribe's cultural, social or community activities such as pow-wows, ceremonies and traditional dances; (2) pay or reimburse travel expenses to visit other Indian reservations or sites that are culturally and historically significant for the tribe; (3) pay or reimburse the costs of receiving instruction about an Indian tribe's culture, history, and traditions (such as traditional language, music and dances); or (4) pay or reimburse funeral and burial expenses and expenses of hosting or attending wakes, funerals, burials or similar bereavement events.
For more details, see Holland & Knight’s December 6, 2012 alert,"IRS Proposes General Welfare Exclusion Safe Harbors for Tribal Government Programs."
TO DO IN 2013: Notice 2012-75 provides an opportunity for tribal CFOs, general counsel and tribal leaders to evaluate their current general welfare programs and determine which programs meet the safe harbors described in the Notice. Although a program's failure to meet a safe harbor does not necessarily mean that its benefits are taxable, if a tribe is able to take steps to modify a program to meet the specific and general requirements (such as by establishing written guidelines for the program or modifying some aspect of the program to fit within a specific requirement), it will provide its members with greater assurance that IRS will not be able to assert taxes or penalties in a subsequent audit. Furthermore, if the tribe has treated benefits falling within a safe harbor as taxable over the past three years, it should act now to issue corrected 1099s to its members so that members who may have paid tax on excludable benefits can seek a refund of such tax by filing amended returns for open tax years. In addition, between now and June 3, 2013, comments on the safe harbor should be compiled by the tribe's legal counsel and tax advisors in collaboration with its government affairs and elected leadership.
3. New Developments in Income from Trusts and Trust Settlements
In late 2011, the IRS clarified the requirements for a safe harbor relating to IGRA trusts used to set aside per capita payments for minors and legally incompetent persons. See Rev. Proc. 2011-56. Compliance with the safe harbor requirements permits the tribe to safeguard funds for the trust beneficiaries on a tax-deferred basis, which can result in a significant tax savings in light of rising individual income tax rates, the applicability of the "kiddie tax" and the potential bite of state taxes on off-reservation beneficiaries. Failure to comply with the safe harbor requirements raises the stakes for potential adverse income tax consequences flowing from "constructive receipt" of the income funding the trust before it is actually received by the beneficiaries.
In September 2012, the IRS clarified the tax consequences of income distributed per capita from the settlement of certain trust mismanagement cases between the United States and various Indian tribes. See Notice 2012-60, 2012-41 I.R.B. 445. Using an "origin of the claim" analysis, the IRS concluded in Notice 2012-60 that per capita payments made from settlement proceeds of tribal trust claims must be viewed the same as per capita payments made from funds held in trust by the Secretary of Interior. Based on the Per Capita Act, such payments are exempt from federal and state income taxes. Consequently, per capita payments made from tribal trust settlement proceeds are likewise excluded from the gross income of the members receiving such payments. For further details, see Holland & Knight’s September 17, 2012 alert, "IRS Notice on Per Capital Payments from Tribal Trust Settlement Proceeds Offers Insights and Planning Opportunities."
One area that the 2012 IRS guidance was the tax treatment of income from trust resources, such as timber or oil and gas resources. This is expected to be resolved in future IRS guidance.
TO DO OR WATCH IN 2013: Tribes that maintain trusts or trust accounts to hold per capita income for minors will want to review such arrangements in light of the final minors trust guidance in Rev. Proc. 2011-56 and the potential applicability of the "kiddie tax" to such distributions. Rev. Proc. 2011-56 also provides a useful template, although not a safe harbor, for the establishment of adult deferred per capita trusts, which can be used to defer income in a variety of situations, including high tax rates. Tribal leaders will also be watching to see how IRS ultimately addresses the issue of per capita payments derived from tribal trust resources income.
4. Developments in the Applicability of State and Local Sales Taxes in Indian Country
The extent to which states may impose their sales and use taxes on transactions involving non-Indians making sales and/or purchases on Indian reservations continues to be a difficult area for tribes. Although three decades have passed since the U.S. Supreme Court established tests that determine when states are precluded from imposing their taxes, applying those tests has proven difficult for both tribes and states, and for the courts. The limits of state sales/use tax authority will continue to pose challenges in 2013 as tribes seek to maintain control of taxes imposed on their lands.
In an attempt to provide clarity on this matter, some tribes have entered into tax compacts that allocate taxing authority and revenue between tribal and state governments. Some states — including California, North Dakota and Wisconsin — issued written guidelines in 2012 on the application of sales/use tax in Indian country. In 2013, the application of compacts and new guidelines will be tested as tribes and states begin implementing them.
On the federal level, Congress is giving serious consideration to legislation that clarifies the sourcing of remote sales transactions (including those conducted by telephone, Internet or mail order) and permits states to collect sales tax on such transactions. If passed, this legislation would establish the jurisdictional rules that govern the ability of tribes to impose and collect sales tax on Internet and other remote sales. Unless tribes are included in the legislation, they may not be able to collect sales tax on remote transactions even when the sales would be sourced to a tribe's reservation. Similarly, if tribal interests are not protected, states may be able to tax purchases by tribes and tribal members that are not currently taxable by states under prevalent Supreme Court rules.
TO DO IN 2013: As Congress appears poised to pass some form of legislation on this matter in 2013, the National Congress of American Indians (NCAI) and other organizations are urging tribes to get involved. These groups and their members want to ensure that any legislation passed by Congress protects the tax status of tribal governments by allowing them to impose their taxes in the same manner as states. Absent tribal inclusion in the legislation, tribes could lose an increasingly important source of governmental revenue.
5. State and Local Taxation of Tribal Trust Lands and Property
Regulatory reform implemented at the end of 2012, coupled with passage of the Helping Expedite and Advance Responsible Tribal Homeownership Act (HEARTH Act) just months earlier, significantly increased tribal control — and decreased state control — over the taxation, use and development of Indian lands. Similarly, a comprehensive tax ruling issued by the U.S. District Court for the District of Connecticut precluded a local government from taxing personal property leased by a tribe on its reservation. As that ruling heads to court on appeal, however, and as states and the federal government begin implementing the new regulations, the true extent of tribal control over property tax on Indian lands remains to be determined.
Taxation of Property, Activities or Leasehold Interests on Indian Trust and Restricted Land
The HEARTH Act, signed into law on July 30, 2012, authorizes Indian tribes to lease their Indian lands for business and other purposes for up to 75 years without review and approval by the Secretary of the Interior. The Act eliminates significant delays and costs and grants tribes increased control over business operations on their land.
The Bureau of Indian Affairs (BIA) further increased tribal control over leasing on Indian lands in November 2012 when it announced new leasing regulations (25 CFR 162) that fundamentally alter BIA's handling of lease approvals by minimizing its role and streamlining its operations. Some of the major changes wrought by the new regulation include a separate and simplified process for residential, business and renewable energy development, a 30-day limit for BIA to issue decisions on residential leases, subleases and mortgages, and increased flexibility in compensations and land valuations. The regulations also eliminate the requirement that BIA approve permits for some types of short-term activities on Indian lands.
In addition to granting tribes increased control over the leasing of trust and restricted property, the new regulations also added a section, 162.017, strongly suggesting that state and local governments generally may not impose their taxes on property, activities or interests associated with leased Indian trust or restricted land. The new section provides that "subject only to applicable Federal law," permanent improvements on leased trust or restricted land are not subject to any state or local fees or taxes; activities under a lease of such land are also not subject to state or local fees or taxes (such as business use, privilege, public utility, excise or gross revenue taxes); and the leasehold or possessory interest itself is not subject to any state or local fee or tax. Tribes, on the other hand, are permitted to tax improvements or activities on leased land, and may tax leasehold or possessory interests in such land. 77 Fed. Reg. at 72472. Also see the example of 162.017 in preamble at 77 Fed. Reg. at 72447-72448.
TO WATCH IN 2013: The BIA leasing regulations appear to prohibit state and local governments from taxing Indian leases (and related activities and improvements) unless federal law permits such taxation. Whether federal law permits state and local taxation depends, to some extent, on the facts and circumstances under the interest-balancing test enunciated in White Mountain Apache Tribe v. Bracker. The BIA regulations, however, place a heavy thumb on the scale in favor of tribal interests.
Taxation of Personal Property
In 2012, the judiciary also favored tribal interests in a decision involving personal property leased by a tribe from a private property company for use in its on-reservation gaming operations. In April 2012, United States District Judge Warren W. Eginton held that a local government could not tax slot machines owned by non-Indian gaming machine companies and leased by the plaintiff, the Mashantucket Pequot Tribe.See Mashantucket Pequot Tribe v. Town of Ledyard, Slip Copy, 2012 WL 1069342 (D.Conn.). Unlike many recent Indian tax rulings, which tend to follow a single line of reasoning based on White Mountain Apache Tribe v. Bracker, 448 U.S. 136 (1980), Judge Eginton held that the property tax was preempted on three separate grounds: the federal Indian Trader Statutes, the Indian Gaming Regulatory Act, and federal and tribal interests weighed under the Bracker criteria. See Holland & Knight's April, 3, 2012 alert, "Federal Judge Issues Comprehensive Tax Ruling Preempting Local Property Taxes on Casino Slot Machines."
TO WATCH IN 2013: The extent to which state personal property taxes are preempted remains to be determined as the Mashantucket Pequot case heads to court on appeal. Plaintiffs in the Mashantucket Pequot appeal — the State of Connecticut, the Town of Ledyard and others — have asked the U.S. Court of Appeals for the Second Circuit to determine whether, and on what basis, local governments may tax property leased by a tribe for use on its reservation. The court will likely provide its answer in 2013.
6. Options for Tax-Advantaged Financing for Tribal Economic Development Projects
In 2012, we saw continued signs of both administrative and legislative support for a permanent fix to the tribal bond rules, but no introduced bills. In early 2012, the administration's budget contained a tax proposal to permanently repeal the essential governmental function test and the restriction on tribal private activity bonds. Then, at a May 2012 Senate hearing, Finance Chairman Max Baucus (D-Mont.) announced his support for parity between the bond rules that apply to state and local governments and to tribes. Legislation addressing this issue is expected to be included in a comprehensive tax reform bill that will be high on the agenda of Congress this year.
On July 16, 2012, the IRS released Notice 2012-48, which solicits applications for the allocation of available amounts of national bond issuance authority limitation (volume cap) for Tribal Economic Development Bonds (TEDBs) under Internal Revenue Code Section 7871(f). The Notice provides guidance on the application requirements and forms for requests for volume cap allocations, the general process that will be used by the IRS to allocate the volume cap, and information reporting to the IRS concerning various aspects of the allocation process and the issuance of TEDBs. For detailed information on the requirements and procedures, see Holland & Knight’s July 26, 2012 alert, "Expanded Tribal Bond-Issuing Authority: IRS Issues New Guidelines on Tribal Economic Development Bonds."
TO DO IN 2013: CFOs responsible for arranging financing for tribal facilities and projects will want to assess the viability of traditional tax-exempt financing (no location test or application formalities, but must meet essential governmental function test), TEDB financing (reservation location test, gaming restriction and must apply for allocation of volume cap) and taxable financing. Tribal leaders and government affairs representatives will have an opportunity to work with national tribal organizations and Congress on legislation to liberalize the rules governing tribal financings.
7. Tribal Business Structure Tax Planning
The 2012-2013 Priority Guidance Plan released in late 2012 by the Department of Treasury and the IRS has once again listed as a priority project the development of regulations "providing criteria for treating an entity as an integral part of a state, local or tribal government." For details, click here and see page 15.
This particular item has been on the Treasury-IRS plan each year since 2007, and since the early 2000s, Treasury prioritized the issuance of guidance on corporations chartered under tribal law. Unfortunately, no such guidance has been issued, and with the advent of the "integral part" regulations projects, IRS is currently not willing to provide private letter rulings on when a tribal law corporation is considered an "integral part" of the tribe — all of which makes business planning difficult, to say the least.
TO WATCH IN 2013: It is difficult to predict whether IRS guidance (most likely, in the form of an advanced notice of proposed rulemaking) will be issued in 2013. In the interim, Section 17 corporations and wholly-owned LLCs continue to be favored as providing relatively certain (and very favorable) tax treatment as well as other benefits in a business planning context. But tribal law corporations also continue to be utilized for some purposes, notwithstanding their uncertain tax status.
8. IRS Audits of Tribes and Tribal Casinos
In Senate and House hearings held in 2012, the IRS was questioned about what seems to Indian Country as disproportionate audit coverage aimed at Indian tribes, particularly tribes earning and distributing revenues from gaming. Notwithstanding requests from tribal leaders for an IRS "audit moratorium," IRS examinations of tribe and tribal casinos are expected to continue — although IRS seems to be deploying more resources in education and consultation functions. In a decision rendered on October 15, 2012, the U.S. Court of Appeals for the Eleventh Circuit upheld the IRS's power to review an Indian tribe's financial records as part of an investigation into the distribution of gaming profits. See Miccosukee Tribe of Indians of Florida v. United States (11th Cir. 2012).
Tribal audits over the past several years have focused heavily on the issuance of 1099s to vendors, gambling patrons and prize winners, wage withholding, per capita withholding and the payment of employee and non-employee "business expenses" (whether or not under an accountable plan). In several instances of which we are aware, a tribe's lack of compliance with the accountable plan requirements has led to the assessment of significant amounts of additional taxes and penalties by the IRS.
TO DO IN 2013: Review reporting and withholding with tax counsel to make sure that proper amounts are reported, withheld and deposited with IRS. Review procedures and documentation for payment and/or reimbursement of expenses for employees, tribal officers, and tribal committee members (including those serving the tribe in a "volunteer" capacity) to make sure that accountable plan requirements are met.
9. "Casino Comps": An Area for Future IRS Guidance
Although the issue has rarely arisen on audits of tribal casinos, there have been recent indications that the IRS may soon be developing comprehensive guidance on how casino comps are treated for tax and reporting purposes. The current state of IRS guidance on casino comp is sketchy at best, and not completely consistent with the handful of decided cases that have addressed this issue. The major issue for tribal casinos is what types of "comps" have to be treated as income (as opposed to nontaxable reductions in the purchase price of the gaming entertainment) and how taxable "comps" should be reported.
TO DO IN 2013: Review existing practices in light of existing IRS guidance and case law and watch for possible new guidance later in the year.
10. Federal Tax Reform
Federal tax reform is likely to take center stage in 2013 as Congress struggles with how to make the tax code fairer, simpler and less damaging to American companies competing in the international arena. Maintaining and increasing tax revenues is also a major concern as federal deficits continue to balloon.
For tribes, federal tax reform is a danger, but also an opportunity. National and regional tribal groups have put together legislative proposals for possible inclusion in federal tax reform legislation. Such proposals include:
tax-exempt bond reform, as well as financing and investment parity provisions
excise tax parity
treatment of tribal charities
kiddie tax reform (exempting tribal government distributions from the kiddie tax rates)
tribal pension reform (treating tribal plans like state/local government plans)
participation of tribes in streamlined sales tax
The common theme behind many of the provisions listed above is tribal tax parity — i.e., treating tribes the same as state and local governments for federal tax purposes.
TO DO AND WATCH IN 2013: Although some of the spade work on tax reform was completed in 2012, it will be up to tribal leaders to make their voices heard on Capitol Hill in 2013 as Congress considers systemic changes to the tax code. First and foremost, tribal leaders and their representatives will want to vigilantly protect the existing tax-immune status of tribes and tribal entities. In addition, if Congress proves to be serious about rationalizing the tax code, all of the proposals listed above should be included in an omnibus tax reform bill.