Top 10 Indian Tribal Tax Developments In 2013 And Priorities For 2014

Kathleen Nilles is a Partner and Kenneth Parsons is an Associate in the Washington D.C. office Zehava Zevit is a Senior Counsel in the Los Angeles office Brent Berselli is an Associate in the Portland office

HIGHLIGHTS:

In 2013, courts were active in issues relating to Indian tribes, including ruling on state tax matters and the federal income tax aspects of Section 17 corporations. The top 10 Indian tribal tax developments from 2013 and how they are likely to influence the priorities of tribal leaders, legal counsel, financial officers and government affairs representatives in 2014 are discussed in this alert. General welfare captured much of the attention of lawmakers and the Internal Revenue Service in 2013. Courts were also active last year in issues relevant to Indian tribes, ruling on state tax matters and the federal income tax aspects of Section 17 corporations. 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 2014.

1. General Welfare Tax Planning

   The general welfare doctrine's application to tribal government programs was a hot topic in 2013. Much of the attention was due to Notice 2012-75, proposed administrative guidance issued by the IRS in December 2012. Notice 2012-75 offers a safe harbor applicable to specific types of tribal governmental programs under which IRS will presume that the "individual or family need" requirement of the general welfare doctrine is met. Safe harbor programs include certain housing, educational, religious, elder and disabled programs. All qualifying programs must also meet certain general procedural requirements in order to meet a safe harbor. These include written program eligibility guidelines and a requirement that the benefits provided not be lavish or extravagant. For detailed information on Notice 2012-75 and the safe harbor requirements, see Holland & Knight's alert, " IRS Proposes General Welfare Exclusion Safe Harbors for Tribal Government Programs," Dec. 6, 2012.

   Indian country's response to the proposed guidance was swift and generally positive. During the first half of 2013, a number of Indian tribes and tribal organizations prepared comments on Notice 2012-75 seeking to clarify, and in some instances expand, the safe harbors. IRS is reviewing these comments as it works on final guidance, which it anticipates releasing sometime this year.

   Some tribal leaders believed that Notice 2012-75 did not go far enough. They worked with Rep. Devin Nunes (R-Calif.) on legislation that would amend the Internal Revenue Code to provide a federal income tax exclusion for certain general welfare benefits provided by Indian tribes. The bill, titled the "Tribal General Welfare Exclusion Act of 2013," was introduced in Congress in August 2013. The proposed legislation tracks the general procedural requirements in Notice 2012-75, but unlike the notice, it does not limit the general welfare exclusion to specific types of governmental programs. Rather, the proposed legislation would apply to any tribal governmental program if the benefits provided under such program are for the promotion of general welfare and satisfy certain other procedural requirements, including one limiting the exclusion to benefits that are not lavish or extravagant. The bill also would establish a Tribal Advisory Committee to advise Treasury on matters relating to the taxation of Indians and temporarily suspend all general welfare-related audits and examinations of Indian tribal governments and members of Indian tribes.

   TO WATCH IN 2014: The IRS anticipates releasing final guidance under the general welfare doctrine sometime in 2014. Tribal leaders should also monitor the progress of the General Welfare Exclusion Act of 2013 in Congress. Rep. Nunes' bill currently has 40 co-sponsors, while Senator Jerry Moran's (R-Kan.) companion bill in the Senate has seven co-sponsors. Neither bill has seen any activity since being referred to committee.

   TO DO IN 2014: Although IRS anticipates issuing final guidance under the general welfare doctrine at some point during 2014, taxpayers may apply Notice 2012-75 until additional guidance is issued. Tribes should not wait to modify their programs to comply with the safe harbors in order to maximize federal income tax exclusions for their members. In addition, if the IRS consults again with Indian tribes before releasing final guidance, tribal leaders should be prepared to contribute to that dialogue.

2. New Developments Regarding Taxation of Tribal Trust Settlements and Trust Resources

   In 2013, the IRS issued two additional notices updating Notice 2012-60 regarding the federal tax treatment of per capita payments that members of Indian tribes receive from proceeds of certain settlements of tribal trust cases between the United States and those Indian tribes — IRS Notice 2013-1 and Notice 2013-55, both posted on the IRS website. The two 2013 notices add 15 additional tribes to the list of tribes with trust settlements qualifying for exclusion from income tax when the settlement funds are distributed on a per capita basis to their members.

   What IRS failed to do in 2013 was extend its guidance to per capita distributions from tribal trust resources. In 2012, two congressional committees held hearings lamenting IRS' inconsistent treatment of income derived from trust resources when distributed per capita to tribal members. IRS indicated at the September 2012 hearing before the House Natural Resources Subcommittee on Indian Affairs that it would consult with tribes and issue specific guidance on income from trust resources. But no such consultations were formally scheduled and no further guidance has been issued.

   TO DO OR WATCH IN 2014: Notwithstanding the apparent lack of progress, IRS personnel have informally indicated that they are in the process of consulting with the U.S. Department of the Interior (DOI) on the definition of a "trust resource" and the scope of the guidance. Guidance is expected to be issued in 2014, but the timing remains uncertain. In the interim, most tribes are continuing to take the position that if the source of the funds is eligible for deposit in a trust account (such as funds derived directly from trust land or restricted fee lands), then those tribal funds may be distributed to individual tribal members on a tax-free basis.

3. IRS Audits of Tribal Governments, Tribal Members and Tribal Casinos

   Notwithstanding significant public criticism and congressional oversight, IRS continued to conduct examinations of tribal governments and casinos in 2013, and in some cases, coordinated audits of tribal members. However, based on anecdotal evidence, the primary focus of tribal government audits appears to have shifted away from tribal government programs per se and toward payroll tax compliance, employee classification, and other forms of withholding taxation and reporting (such as withholding or reporting required on the various types of per capita payments). In the case of casinos, the primary focus is on the casino's compliance with the complex withholding and reporting rules applicable to the various types of gambling winnings, as well as on employee payroll tax, employee classification and reporting of payments to vendors. Where the tribe refuses to cooperate with IRS in such audits (or in the collection of assessed taxes and penalties), the IRS has opened audits of tribal members and has asserted "responsible officer penalties" against individual officers and directors responsible for...