IRS Notice on Per Capita Payments from Tribal Trust Settlement Proceeds Offers Insights and Planning Opportunities

by Holland & Knight LLP
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On September 6, 2012, the Internal Revenue Service (IRS) issued Notice 2012-60, which addresses the federal income tax treatment of per capita payments made from the proceeds of settlements of certain Indian tribal trust claims. The Notice primarily relates to the more than $1 billion settlement the United States entered into with 41 tribes on April 11, 2012. The IRS's legal analysis in the Notice likely will have broader application, however, especially considering that the United States anticipates entering into similar settlements with other tribes. It also may lay the groundwork for the potential resolution of controversies with tribes over their per capita distribution of funds derived from tribal trust resources, such as timber located on tribal trust land harvested by the tribes.

Background

The April 11, 2012 settlement relates to claims dating back over 100 years in which certain Indian tribes alleged that the Department of Interior and the Treasury Department mismanaged monetary assets and natural resources held in trust by the United States for the benefit of the tribes. The Department of Interior manages more than 50 million acres of trust lands for Indian tribes and more than 100,000 leases on those lands for various uses, including farming, grazing, timber harvesting, oil and gas extraction, housing, business leasing and easements. In addition, the Department of Interior manages approximately 2,500 tribal trust accounts for more than 250 tribes.

Most of the Indian tribes involved in the April 11, 2012 settlement directed the United States to transfer their portion of the settlement proceeds to accounts at private banks or other third-party institutions, where the funds will be invested until used by the tribes for various purposes, including making per capita payments to their members. Other tribes directed that all or a portion of their settlement proceeds be paid into a trust account established or maintained by the Secretary of Interior for the benefit of the tribes until the tribes provide instructions for the disposition of the proceeds, which may include making per capita payments to their members. The tribes requested consultation with the IRS on the federal income tax treatment of per capita payments from the proceeds of the settlement, which resulted in the publication of the Notice.

The Notice

The IRS first noted that, except as otherwise provided by law, gross income includes "all income from whatever source derived." It then cited the Per Capita Act (25 U.S.C. §§117a-c), which authorizes Indian tribes to make per capita payments to their members from funds held in trust by the Secretary of Interior, and provides that such payments "are subject to" the Indian Tribal Judgment Funds Use or Distribution Act (25 U.S.C. §§1401-1408). The Tribal Judgment Funds Act provides an exclusion from gross income to Indian tribes for certain judgment funds and for all interest and investment income accrued on such funds while held in trust.

The IRS cited Raytheon Production Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir. 1944), aff'g 1 T.C. 952 (1943) for the proposition that the fact that a suit ends in a settlement does not change the nature of the recovery. Raytheon involved the tax character of the proceeds of a settlement of a suit for damages for violations of antitrust laws. The court examined the nature of the underlying claim to determine the federal tax treatment of the settlement proceeds, stating "[t]he test is not whether the action was one in tort or contract but rather the question to be asked is 'in lieu of what were the damages awarded?'"

Using an "origin of the claim" analysis, the IRS concluded in the Notice that per capita payments made from the settlement proceeds of the 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 excluded from the gross income of the members of the tribe receiving such payment.

The IRS reasoned that, because the settlements resolved claims that the Department of Interior and Department of Treasury mismanaged trust accounts, land and natural resources, the settlement proceeds "must be viewed as being lieu of amounts that would have been held in a trust fund account for the tribe that is maintained by the Secretary of Interior." Consequently, per capita payments that an Indian tribe makes from the tribe's settlement proceeds are treated, for federal income tax purposes, the same as per capita payments from funds held in trust by the Secretary of Interior under the Per Capita Act.

The IRS also concluded that any per capita payments that exceed the amount of a tribe's settlement proceeds are included in the gross income of the recipient if the proceeds come from a private bank or other third-party institution. Per capita distributions in excess of settlement proceeds are not included in gross income if the funds are held in trust by the United States, however. The difference in treatment is due to Section 1407 of the Tribal Judgment Funds Act, which the IRS views as providing a gross income tax exclusion for interest and investment income accrued on judgment funds only while such funds are held in trust.

Significance of the Notice

Although the Notice only applies to the tribes that have entered into settlements with the United States in connection with their tribal trust claims, any future settlements of tribal trust claims likely will be subject to the same guidance. In view of the fact that the government expects to enter into similar settlements with other Indian tribes, the Notice offers valuable insight to tribes that are considering their own trust claims against the United States. The Notice also provides an opportunity for other tribes to structure their settlements in a tax-efficient manner.

For example, a tribe may choose to direct that a portion of its settlement proceeds be paid into a trust maintained by the Secretary of Interior because, unlike settlement proceeds deposited into a private bank, those proceeds can grow tax-free, even if they are later used to make per capita payments to members of the tribe. Another tax savings measure would be to prioritize full distribution of tribal settlement proceeds, perhaps re-directing some gaming revenues to the general fund given that gaming per capita distributions are fully subject to taxation and withholding. 

The IRS stated in the Notice that the federal income tax treatment of other per capita payments may be addressed by future guidance. Although the IRS did not indicate what other guidance it may issue, it is possible that the IRS would employ an analysis similar to the one in the Notice in other contexts, such as per capita payments made from other types of tribal claims, other judgment funds or tribal trust accounts in general. It is noteworthy, however, that the IRS did not clearly indicate in the Notice that there is a broad federal income tax exemption for per capita payments made from tribal trust resources or tribal trust accounts. 

On Friday, September 14, the House Committee on Natural Resources held a hearing to review the tax treatment of tribal trust resource payments. The Committee members present at the hearing were critical of a letter sent to at least one Indian tribe earlier this year, which signaled the IRS’s intention to tax per capita distributions of certain tribal trust resource payments. The Committee members asked Christie Jacobs, the Director of the IRS’s Office of Indian Tribal Governments, how the IRS planned to reconcile its position in the letter with the guidance issued in Notice 2012-60. Ms. Jacobs stated that the IRS planned to apply the “legal underpinnings” in Notice 2012-60 to a broader context, and indicated that future IRS guidance would clarify that per capita distributions of tribal trust resources are exempt from federal income taxation.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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