The Senate Finance Committee held a hearing Tuesday to examine the impact of tax reform on Native American tribes and U.S. territories such as Puerto Rico, the U.S. Virgin Islands, Guam, American Samoa and the Northern Mariana Islands.
“Indian governments and the territories are in some ways similar to state governments,” said committee chairman Sen. Max Baucus, D-Mont., in a statement. “Each provides hospitals, public schools and law enforcement. But U.S. policies do not recognize tribal governments or territories as states or fully sovereign nations. Instead, U.S. law is a patchwork of complicated rules for each territory. And for tribal governments, U.S. policies are inconsistent. Tax policy is a microcosm of this inconsistency.”
Baucus noted that the unemployment rate on some reservations, such as the Northern Cheyenne reservation in Montana and the Pine Ridge reservation in South Dakota, is 80 percent. One in four Indians lives below the poverty line. American Indians’ median income is 31 percent less than all other Americans. U.S. territories and commonwealths also suffer from high unemployment.
“In the past, Congress has recognized the special status of tribal governments and the island territories and taken steps through our tax policies to improve their economic conditions,” he added. “We provided accelerated depreciation for capital investments and an employment credit for businesses located in Indian country. Congress also allowed businesses to claim a credit for the production of coal from Indian land. The accelerated depreciation provision brought jobs and economic activity to the Crow Tribe in Montana when Westmoreland Coal used it to boost profits.”
However, Baucus noted that there are issues with these provisions. Two-thirds of the state of Oklahoma qualifies as an eligible Indian reservation under the accelerated depreciation provision and employment tax credit as written. “Perhaps the tax laws need to be better targeted,” he said.
Seneca Nation of Indians President Robert Odawi Porter discussed the history of his tribe and the many broken treaties and promises made by the federal government over more than 200 years.
“We have long believed that our treaties with the United States require that the Seneca Nation, our people and our lands, be treated as immune from federal and state taxation,” he said. “By legislation and agreement, the United States has generally recognized this tax immunity and our Nation’s inherent, sovereign right to regulate all conduct within our territories free of interference by all other governments. Moreover, the Congress has never expressly authorized the direct taxation of individual Indians.
“However, many aspects of our treaty-recognized freedoms have been eroded over time, particularly those that originally protected our individual tribal citizens,” Porter added. “All three branches of the federal government— judiciary, executive, and legislative—have directly caused or allowed this erosion to occur. Without any express congressional authorization, over the last 60 years the Treasury Department has forced tribal citizens to become taxpayers in violation of our treaty status. Forcing us to pay taxes—such as income taxes, payroll taxes, and excise taxes—undermines our treaty-protected immunities. It must be remembered that our treaties with the United States reflect the payment of our ‘tax bill’ in perpetuity. Indian people gave up nearly all of our lands in fulfillment of any and all obligations that might ever be owed to the United States in the future.”
General Welfare Exclusion
A primary area of concern for tribal governments is the application of the general welfare doctrine. The doctrine allows governments to provide benefits to citizens without those benefits counting as taxable income.
“Tribes provide many benefits to their members including educational assistance and cultural awareness, along with housing and meals,” said Baucus. “But it’s often unclear which benefits are eligible for the exemption. That uncertainty is tough on families and tribal governments, and it’s something we should fix.”
“With respect to tribal tax issues, certain of them, such as the general welfare exclusion, seem to have been outstanding for several years, and this committee needs to determine the scope of actions to be taken when fundamental tax reform is finally realized,” said Sen. Orrin Hatch, R-Utah, the ranking Republican member of the committee.
IRS Tax Exempt and Government Entities Commissioner Sarah Hall Ingram testified about the consultations that the IRS and the Treasury Department have been having with tribal leaders on the general welfare exclusion.
“Tribes, like all governments, sponsor social welfare programs designed to support their members,” she said. “Of principal relevance to the IRS is whether payments made through those social welfare programs are taxable. To be very clear, whether this exclusion is or is not applied does not limit what benefits or social programs tribes can provide to their members. The question is whether the provision of those benefits is excludable from general income under the general welfare doctrine.”
She noted that at various times, different tribes and tribal leaders have voiced concerns over the application of the exclusion provided under the general welfare doctrine. Last November, in response to consultation sessions and meetings with tribes and tribal leaders, and internal IRS and Treasury discussions, the IRS issued Notice 2011-94, which invited comments concerning the application of the general welfare exclusion to Indian tribal government programs. The purpose of the Notice was to begin a consultation process with tribes on how to find a solution that addressed their concerns and improved clarity and consistency of the tax law.
The IRS has received over 65 written comments from tribes and tribal leaders submitted in response to Notice 2011-94, Ingram noted, and is still reviewing those comments as it considers the next step in the process. In March, the Treasury and the IRS participated in a consultation session hosted by the National Congress of American Indians in conjunction with their annual conference and attended by approximately 40 tribal representatives. The IRS and Treasury intend to host another consultation session through teleconference on May 30 (see IRS Consults with Tribal Leaders on Welfare Exclusion).
The IRS eventually plans to publish written guidance that will address issues raised by tribes in their comments. “Our intent is that this published guidance, along with improved internal coordination procedures, will provide increased clarity and consistency of the application of the general welfare doctrine,” said Ingram. “In the process of doing so, we will respond to many of the concerns which we have heard through the written and in-person consultation sessions. Our goal is to publish guidance as soon as possible. Tribal concerns are very important to us and we look forward to working with tribes on this item in the future.”
Tax-Exempt Bonds for Tribal Governments
Baucus noted that Congress should level the playing field for tax-exempt bonds for tribal governments. While states are currently allowed to issue tax-exempt bonds for any public purpose, tribal governments can only issue bonds for government buildings, and their bonds have to pass an “essential government test.”
To address this inequity, in 2009 Congress authorized $2 billion of tribal economic development bonds for any purpose other than gambling facilities. The Treasury Department studied the program and recommended that Congress repeal the essential government test. “We should do this as part of tax reform,” said Baucus.
Ingram of the IRS discussed the use of tax-exempt bonds. She noted that the Indian Tribal Governmental Tax Status Act of 1982 added Section 7871 to the Tax Code, which grants Indian tribal governments the authority to issue tax-exempt bonds. This provision does have a limiting provision, however, as it generally requires that proceeds of tribal tax-exempt bonds be “used in the exercise of an essential governmental function.”
Further, Section 7871 also provides that tribes are not allowed to issue private activity bonds except in limited circumstances to finance certain manufacturing facilities, she noted.
“Since enactment in 1982, we have consistently heard from tribes that these requirements significantly limit the ability of tribes to fund certain projects and that these requirements are unfairly restrictive in comparison to the more flexible standard for tax-exempt bond financing that applies to state and local governments,” said Ingram.
The American Recovery and Reinvestment Act of 2009 created a new type of tribal tax-exempt bond authority generally referred to as “tribal economic development bonds” and authorized $2 billion in bond authority for the new bond program.
“Tribal economic development bonds are not subject to the essential government function test applied to traditional tax-exempt bonds for tribal governments,” said Ingram. “This key difference allows tribal governments to fund projects that they would not historically have been authorized to fund with tax-exempt bonds.”
In 2010, under the Recovery Act, the IRS allocated the authorized tribal economic development bond authority in two tranches, she noted. The entire $2 billion volume cap was allocated. Through the end of 2011, however, less than 3 percent of the tribal economic development bonds were ultimately issued. “The IRS has consulted with tribes and has received constructive feedback on causes of the low issuance rate,” said Ingram. “Among other reasons, tribes have stated the low issuance rate was due to the allocation period being too short, the new bond characteristics not being readily understood, credit constraints impede access to the market for tribes, and the national economic environment not being conducive to new bond issuances.”
Last November, the IRS formally solicited written comments from tribes on how to improve the allocation process for tribal economic development bonds. Ingram noted that most of the $2 billion in tribal economic development bond volume cap remains available for re-allocation after administrative expiration of the unused allocations at the end of 2011. The IRS received numerous written comments from tribes and is reviewing the submitted comments in order to determine what adjustments can be made in a revised allocation process in order to facilitate an increase in the issuance rate. After carefully considering the comments received, the IRS expects to issue public guidance in the near future to announce a revised process for reallocating the unused bond volume cap for Tribal Economic Development Bonds.
“Tribes are now and have always been handicapped under federal law when it comes to the raising of capital for economic development activities,” said Lindsay G. Robertson, a law professor at the University of Oklahoma College of Law. “Since the Trade and Intercourse Act of 1790, tribal land sales without federal authorization have been invalid under federal law. While this restriction undoubtedly led to the retention of tribal lands that might otherwise been lost, it had the unintended effect of making tribal lands unavailable as security for conventional loans. Free alienability of such lands is not the solution as long as tribal jurisdiction is closely tied to land tenure. Instead, the solution must involve the creation of compensatory capital-generation devices.”
Authorizing tribes to issue tax-exempt bonds was a step in the right direction, Robertson added. “However, the ‘essential government function’ limitation imposed on the use of funds raised through such bonding limited its utility as an engine for economic development,” he said. “It is worth noting that the ‘essential government function’ limitation is not applied to limit the use of funds raised through tax-exempt bonding by states and municipalities. The elimination of the limitation on tax-exempt bonding by tribes would free tribes to raise capital otherwise unavailable to them and make it possible for them responsibly to create their own solutions in today’s difficult economic times.”
Tax Extenders for Tribes and Territories
The question of tax reform also was considered during the hearing in the context of tax extenders that are of particular relevance to Native American tribes and U.S. territories. “Several so-called tax extenders explicitly designed to aid Native American tribes, such as accelerated depreciation for business property on Indian reservations, have actually expired,” said Hatch. “The credit for the production of Indian coal will expire at the end of this year. If we are going to break out of the repetitive loop of short-term extensions, we should not put off a discussion of these temporary measures, even prior to comprehensive tax reform.”
For U.S. territories, Baucus noted, federal tax law previously contained an economic activity tax credit and a possessions tax credit to encourage investment. These credits expired at the end of 2005. Another provision set to expire sends a portion of excise taxes on rum to two territories to help fund their government operations.
“In a nutshell, even though the people of the various possessions are United States citizens or nationals, most do not pay tax to the federal government, but rather to their possession’s government,” said Hatch. “Some U.S. possessions have a mirror tax code, with tax laws essentially identical to the U.S. Internal Revenue Code, simply swapping the name of the possession wherever the Internal Revenue Code says United States. Yet others are given more autonomy to write their own tax laws as they see fit.
“In some ways, possessions are treated like foreign countries,” Hatch added. “In other ways, however, they are treated like states. For example, research and development in a territory is eligible for the R&D credit, just as if the R&D were performed in a U.S. state. However, income taxes paid to a possession’s government are generally eligible for a U.S. foreign tax credit, just as if paid to a foreign government. Of course, taxes paid to a state government are not creditable, and only sometimes deductible.”
Steven McGuire, a specialist in public finance at the Congressional Research Service, testified about taxation in U.S. territories. “The U.S. taxes residents and corporations located in the territories differently than if they resided in the United States,” he said. “For individuals residing in the territories, their tax treatment is most similar to the tax treatment of foreign citizens. Generally, territorial residents are exempt from federal taxes on territory-sourced income but are—with some exceptions—taxed on income sourced in the U.S. In contrast, U.S. residents are subject to federal taxes on their territory-source income as if it were foreign-source income. However, territorial taxes can generally be claimed as foreign tax credits to offset U.S. tax liability. Thus, as with foreign-source income, the United States concedes primary tax jurisdiction to the territory where the income is earned. With some exceptions, it retains primary tax jurisdiction over U.S. sourced income earned by territorial residents.”