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Recently adopted federal legislation and IRS guidance have provided tribal leaders with new ways to structure tribal programs and plans that can reduce federal and state taxes imposed on individual tribal members.
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Five steps that tribal leaders can take this year to reduce federal and state tax burdens for their members include: 1) maximizing excludable benefits and general welfare payments; 2) maximizing distributions from non-taxable sources of tribal revenue; 3) promoting home ownership and charitable giving; 4) adopting a deferred per capita savings plan for elective deferrals; and 5) conducting a tax-efficiency audit of the tribe's minors trust.
Contrary to popular misconception, individual members of Indian tribes do pay federal income taxes on their income, including on most of the income derived from Indian tribal or reservation sources. Some also pay state income tax on many income sources. Moreover, tribal member income is generally subject to tax at full "ordinary income" rates – not the reduced rates applicable to capital gains or corporate dividends. Many tribal members also have few deductions and limited options for deferring tribal income, such as through the use of a 401(k) or IRA, unless they are actually employed by the tribe.
However, there are a few actions that tribal leaders can take to reduce federal (and in most cases, state) taxes on tribal member income. Thanks to the passage of recently enacted federal legislation, as well as some favorable IRS administrative rulings and procedures, tribal leaders now have the ability to structure programs and establish plans that can relieve some of the federal and state income tax burdens otherwise imposed on their members. Here are five things that tribal leaders can do in 2016 and beyond that should have a favorable impact on their members' tax bills.
1. Maximize Excludable Benefits and Payments (General Welfare and Other Exclusions)
With the passage of the Tribal General Welfare Exclusion Act in 2014 and the Affordable Care Act in 2010, there are now two Internal Revenue Code provisions providing exclusions specifically designed to exempt payments made by a Indian tribe to its members (including tribal member spouses and dependents):
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Section 139D (relating to health insurance payments and health benefits)
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Section 139E (relating to payments made pursuant to other tribal general welfare programs)
These two provisions allow Tribes to provide a wide range of excludable benefits (e.g., health, education, housing, elder care and cultural programs) so long as the tribal government programs comply with the specific terms of these Tax Code exemptions. To maximize the potential tax savings, a tribal program inventory should be undertaken to make sure that the existing programs comply with the statutory requirements for exclusion from income and to consider the establishment of new programs to meet the needs of the tribal membership. (See Holland & Knight's alert, "IRS Issues Guidance on Tribal General Welfare Exclusion and Safe Harbors," April 21, 2015.)
2. Maximize Distributions Made from Non-Taxable Sources of Tribal Revenue
Almost all types of revenue are free from federal income tax when earned by an Indian tribe, but some are also free from tax when they are subsequently distributed to the tribe's members. Based on recent IRS guidance interpreting the Per Capita Act of 1982, the following sources of income may be earned by an Indian tribe and distributed to tribal members free of federal (and state) income tax:
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income from leases, easement and other uses of federal trust land
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income from trust resources, such as timber, mineral deposits, oil and gas
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income from the sale of trust land or from damage awards related to trust land.
(See Holland & Knight's alert, "Interim IRS Guidance Confirms Per Capita Distributions from Tribal Trust Resources Are Nontaxable, March 18, 2014, and also "IRS Confirms Per Capita Tribal Trust Payments Not Taxable," Sept. 21, 2015.)
As a long-term goal, all tribes should be looking at opportunities to increase the amount of tribal land held in trust, particularly in light of the myriad tax advantages associated with leasing of trust land.
3. Promote Home Ownership and Charitable Giving
For taxpayers who itemize their deductions, two of the largest deductions are those associated with home ownership (e.g., home mortgage interest and property taxes) and charitable contributions. While a tribal member's decision to own a home or to contribute to a charitable organization is a personal one, tribal leaders can facilitate opportunities for tribal members to own a home and to obtain mortgage financing. Furthermore, tribal leaders can work to let their members know about charitable organizations that support Indian Country priorities.
4. Adopt A Deferred Per Capita Savings Plan for Elective Deferrals of Gaming Revenues
As noted above, per capita distributions are fully taxable at ordinary income rates. Further, since such distributions are not considered "earned income," no portion of the revenues can be contributed by the tribal member into a 401(k) plan or other type of deferred compensation plan. However, a longstanding IRS private letter ruling and more recent IRS revenue procedures confirm that general income deferral principles apply to the taxable per capita revenues. Applying the same principles utilized by rabbi trusts to certain tribal trusts, IRS administrative guidance provides a roadmap for tribes to establish a deferred per capita savings plan that allows tribal members to voluntarily defer receipt of a portion of their per capita distribution by having it placed in a grantor trust owned by the tribe until a set date. Since this type of plan and accompanying trust can only be established by the tribe itself, this is again a situation where tribal leaders can provide opportunities for tribal member tax savings.
Of course, there are many reasons (in addition to current income tax savings) that a tribal member might voluntarily decide to defer a portion of a per capita payment, including:
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as part of an estate plan (particularly where the tribal member's spouse and dependents are not eligible to receive per capita payments after the member's death)
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as a hedge against a downturn in tribal gaming revenues
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as a means of savings to supplement a member's own income in retirement or to cover anticipated long-term care needs
Most tribal leaders have found that members appreciate having options, and this is one that a tribe can establish for its members at minimal expense. (See Holland & Knight's alert, "A Tribal Financial Executive’s Guide to Deferred Per Capita Plans," Sept. 14, 2015.)
5. Conduct a Tax Efficiency Audit of the Tribe's Minors Trust
Since 2003, when the IRS proposed safe harbor requirements for the creation of tax-deferred minors trusts, most tribes decided to establish grantor trusts meeting the IRS safe harbor requirements for the following reasons:
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it simplifies tax compliance by the minor members and their parents by deferring taxation until actual distributions are made
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in so doing, it largely eliminates Kiddie Tax filings (at least for those who do not receive distributions until they are beyond the age when the Kiddie Tax applies)
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the tax-free compounding of investment returns generally offsets the potentially higher effective tax rates applicable to the cash distributions made at age 18 (or older)
Since 2011, when the IRS finalized its minors trust guidance (including provisions that allowed tribes to stagger distributions made to minors over whatever period the Tribe selects), many tribes have decided to restructure their minors trust. In some cases, the trusts are being restructured to delay the age at which distributions are made and/or to include special provisions applicable to minors with special needs.
If a tribe has not already reviewed its minors trust to make sure that it is as tax-efficient as possible, now would be a good time to do so.
