On September 18, 2015, in Notice 2015-67 (the “Notice”), the Internal Revenue Service (“IRS”) issued final guidance on the federal income tax treatment of per capita distributions made to Tribal Members from funds held in Tribal Trust Accounts. See entire Notice here.
By way of background, it has been long standing law that Tribal Members are U.S. citizens and, similar to other U.S. citizens, are subject to federal income taxes on their receipt of income. See Squire v. Capoeman, 351 U.S. 1 (1956) (per capita distributions of net gaming revenues taxable).
The general rule under the Internal Revenue Code (the “IRC”) is that, except as otherwise provided, all accretions to wealth are subject to taxation. See IRC Section 61.
One of the exceptions that exempts income from federal income taxation provides, in general, that per capita distributions to Tribal Members are not subject to federal income tax if the funds are properly held (and allowed to be held) in a Tribal Trust Account (i.e., held in trust by the Secretary of the Interior). 25 U.S.C. Section 1407. See also the Per Capita Act at 25 U.S.C. Section 117a-117c (the “Tribal Trust Account”).
Nevertheless, only certain tribal resources and sources of funds can be properly deposited into a Tribal Trust Account and, therefore, be treated as nontaxable upon distribution of such amounts to Tribal Members. The list of tribal resources that can be deposited into the Tribal Trust Account and be treated as nontaxable upon distribution to Tribal Members can be found at 25 C.F.R. 115.702 (the “Tax Exempt Sources of Funds”). The list includes primarily funds derived from tribal lands, including lease income. More specifically, it includes “[f]unds derived directly from trust lands, restricted fee lands, or trust resources that are presented to the Secretary, on behalf of the tribe or individual Indian oowners of the trust asset, by the payor . . .” The entire list can be found here.
The list of Tax Exempt Sources of Funds does not include per capita distributions to Tribal Members derived from “net revenues” from Indian gaming activity and subject to the Indian Gaming Regulatory Act (net gaming revenues). Instead, per capita distributions to Tribal Members from gaming revenue is subject to federal income taxation to Tribal Members, as well as proper information reporting by the Tribe to the Tribal Members (e.g., Forms 1099).
Lastly, the Notice provides the following examples of where certain per capita distributions are subject to federal income taxation to the Tribal Members where such Tribal funds or resources, although paid out of the Tribal Trust Account, are not included in the list of Tax Exempt Sources of Funds.
The three (3) examples are:
Example 1 – Mischaracterized Compensation
B is a housing authority established by Tribe C, a federally recognized Indian tribe. The Director and the Assistant Director of B are both members of Tribe C. During each of the 2011, 2012, and 2013 taxable years, the Director and the Assistant Director are each paid bonuses in the amount of $15x. In the 2014 taxable year, members of Tribe C’s Tribal Council authorize per capita distributions out of the tribe’s tribal Trust Account in the amount of $1x to every member of the tribe and an additional $2x in per capita distributions to every elder in the tribe. In addition, the members of Tribe C’s Tribal Council authorize distributions out of the tribal Trust Account to the Director and Assistant Director in the amount of $15x each, instead of paying bonuses to the Director and the Assistant Director. The distributions of $15x to the Director and the Assistant Director are mischaracterized compensation and, therefore, are included in their gross income under 26 U.S.C. § 61.
Example 2 – Mischaracterized Distributions of Business Profits
Tribe D is a federally recognized Indian tribe. A group of Tribe D members own Corporation E, an information technology company that provides call center services. Corporation E’s headquarters is located on land held in trust by the Secretary of the Interior for the benefit of Tribe D. Tribe D charges Corporation E rent at fair market value for its headquarters. However, the lease agreement with Tribe D includes a provision whereby Corporation E also deposits an amount approximating its net revenues into Tribe D’s tribal Trust Account, characterizing the revenue as additional rent. Subsequently, members of Tribe D’s Tribal Council authorize per capita distributions out of the tribal Trust Account in an aggregate amount equal to the purported “additional rent” to the group of Tribe D members who own Corporation E. The distributions of the mischaracterized business profits from the tribal Trust Account constitute gross income under 26 U.S.C. § 61 to the members receiving the distributions.
Example 3 – Mischaracterized Gaming Revenues
Tribe F is a federally recognized Indian tribe. Tribe F owns all of Corporation G, which owns and operates a casino located on land held in trust by the Secretary of the Interior for the benefit of Tribe F. All of Corporation G’s gaming revenues are subject to the Indian Gaming Regulatory Act. After paying out all prizes and all administrative expenses (excluding management fees), Corporation G distributes 50% of its net gaming revenues to Tribe F. Also, under a lease agreement with Tribe F, Corporation G deposits the remaining 50% of its net gaming revenues into Tribe F’s tribal Trust Account, characterizing the deposits as rent for use of the land for the casino. Subsequently, members of Tribe F’s Tribal Council authorize per capita distributions to every member of the tribe out of the net gaming revenues that are held in the tribal Trust Account. The distributions out of the tribal Trust Account are mischaracterized gaming revenues. Because per capita distributions of net gaming revenues are subject to federal income taxation, the distributions constitute gross income under 26 U.S.C. § 61 to the members of the tribe receiving the distributions.
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If you have any questions regarding the taxation of per capita distributions, or any other tax questions, please do not hesitate to Eric Swenson at 619-515-3235 or Ted Griswold at 619-515-3277.
Eric is a Senior Counsel in the tax team at Procopio as well as a member of Procopio’s Native American Practice Group. His practice encompasses both tax controversy and tax planning. Eric has represented corporations, individual, and nonprofits before the various tax authorities, including the Internal Revenue Service, Franchise Tax Board and California Board of Equalization. Eric can be reached at 619-515-3235.
Ted is head of the Native American Law Practice Group and primary editor for the Blogging Circle. Connect with Ted at email@example.com and 619.515.3277.