On November 7, 2011, the Internal Revenue Service (IRS) released an “Advance Notice of Proposed Rulemaking“ (the Notice) proposing administrative guidance on when an Indian tribal employee benefit plan – such as a 401(k) plan sponsored by a tribal government employer – would qualify as a “governmental plan.”


In 2006, Congress included a provision in the Pension Protection Act of 2006 that specifically included certain plans sponsored by an Indian Tribal Government (including its subdivisions, agencies and instrumentalities) (an “ITG plan”) in the definition of a “governmental plan” under Section 414(d) of the Internal Revenue Code (Code) and a corresponding provision of the Employee Retirement Income Security Act (ERISA). Indian tribes and their representatives sought this legislation in an effort to confirm that Indian tribal plans would be treated the same as other government plans for tax and ERISA purposes.

However, as a result of last-minute negotiations between House and Senate conferees, Section 906 of the 2006 Act unexpectedly required that all of the participants in an ITG plan be “employees of such entity substantially all of whose services as such an employee are in the performance of essential governmental functions but not in the performance of commercial activities (whether or not an essential governmental function).” Since no such requirement applies to governmental plans established and maintained by federal, state and local government units, the goal of parity was not achieved.

Against the backdrop of this statutory straitjacket created by Congress five years ago, the IRS is now trying to define the key terms “commercial activities” and “essential governmental function” in order to assist tribal employers in the nearly impossible task of determining whether a particular employee benefit or retirement plan is a “governmental plan” under the 2006 Act. If an ITG plan is a governmental plan, it is largely exempt from the Employee Retirement Security Act (ERISA) and from certain Code requirements, such as anti-discrimination testing, annual plan audits and filing the Form 5500.

The Notice solicits written public comment on its proposed definitions and examples and sets a February 6, 2012 deadline. In addition, the IRS will host meetings in a variety of locations to receive input from Indian tribal governments and their representatives.

Issuance of a Second Notice

In addition to the Notice on proposed guidance specific to ITG plans, the IRS simultaneously released a second Advance Notice of Proposed Rulemaking on governmental plan issues that apply to federal, state, local and tribal plans – such as definitions of the terms “political subdivision,” “agency” and “instrumentality” – for purposes of the governmental plan rules. We will address the significance of this second Notice for ITG plans in a future Holland & Knight Alert.

Key Provisions of the First Notice

The Notice describes the following guidance under consideration as the IRS anticipates issuing proposed regulations on the various definitions.

  1. Determination as to whether an entity’s activities are commercial

Under the rules under consideration in the Notice:

  • Commercial activities would include operations involving a casino, a hotel, service station, convenience store and marina.

These activities were identified as commercial activities in IRS Notices 2006-89 and 2007-67, as well as in the Joint Tax Committee’s Technical Explanation of the Pension Protection Act of 2006, so it is not surprising that the proposed IRS guidance would continue to classify them as “commercial.”

  • Commercial activities would also include any activities that meet a facts-and-circumstances test for which the following three factors are proposed: (1) whether the activity is operated to earn a profit, (2) whether the activity is typically performed by private businesses, and (3) whether the activity is a type of activity where the customers are substantially from outside the Indian tribal community, including whether the activity is located or conducted outside of Indian tribal land.

These factors are likely to sweep a large number of activities into the “commercial” activity basket, thus potentially disqualifying many ITGs plans from being classified as governmental plans.

  1. Determination of whether activities of an entity are governmental

Under the rules under consideration in the Notice:

  • Governmental activities would include several new examples of what the IRS will consider to be a “governmental activity,” such as activities related to
    • building and maintenance of public roads, sidewalks, public buildings and related areas, such as parking lots
    • public sewer and drainage facilities, and related activities such as a waste-water treatment
    • public works projects, such as schools and government buildings
    • public utilities, such as electricity and other power sources, including development of newer and emerging technologies
    • criminal protection services, such as police and fire departments
    • civil and administrative services, such as operating public schools, managing and providing services at public hospitals and health clinics, operating the government’s civil service system, and other related public services

In addition, “governmental activities” would include activities subject to treaty or special rules that pertain to Indian trust land ownership and use.

  • The Notice provides a “facts-and circumstances” test for governmental status, but only provides the following two factors for that test: (1) whether the activity provides a public benefit to members of the Indian tribe, and (2) whether one or more of the three “commercial activity” (listed above) are absent. The Notice also proposes that “the generation of revenue from commercial acts” could not be considered as a public benefit to members of the tribe for purposes of this governmental status test.

Although the additional governmental function examples are extremely helpful, they omit such typical governmental functions as recreation, housing and social welfare. The facts-and-circumstances tests are extremely restrictive, particularly in light of the Notice’s proposal to exclude tribal revenue generation from being considered a public benefit to tribal members.

  1. New examples construing the new “commercial” vs. “governmental” tests

The Notice also contains several new examples to illustrate how the IRS would construe the new tests for “commercial” and “governmental” activity.

  • A cultural center and museum owned and operated by a Tribe on its reservation to preserve and display tribal culture is “governmental” even if it includes a “small gift shop” and the majority of its visitors are not tribal members.
  • A community swimming pool owned and operated by a Tribe on its reservation that primarily benefits tribal members is governmental even it non-members must pay a fee to use the pool.
  • An RV park or campground facility primarily serving non-member tourists is “commercial” because it is operated like private for-profit RV parks and campgrounds in the area, and includes customers who are “substantially from outside the Indian tribal community.”
  • A bank owned and operated by a Tribe on its reservation that serves both tribal and non-tribal customers (from both on and off tribal land) and that makes no distinction as to services provided and fees charged to member versus non-member customers is “commercial” because it is operated for-profit like other private businesses.
  • A truck leasing operation in which an Indian tribal government purchases tractors, trailers and other trucking equipment and leases them to a trucking company on a long-term basis is “commercial” because the leasing activity is operated to earn a profit and is the type of activity that is performed by other private businesses.
  • A factory operated by an Indian Tribe on tribal land and that produces goods for sale primarily to non-members is a commercial activity because it is operated to earn a profit and is the type of activity performed by private businesses. The IRS notes that the result could be different if the factory produced goods to “promote and display the culture of [the] Indian tribal government...”  
  1. Determination of employee status under the “substantially all” test

The IRS proposes an approach to determine whether an employee is an employee substantially all of whose services are in the performance of a governmental activity, as opposed to an employee who renders a significant portion of his or her services in a commercial activity. Under the IRS test, the employee’s status would generally be determined by looking at three factors:

  • Location of the employee’s activity (e.g., does the employee perform services in a “government building” or in a “commercial” structure, such as a hotel or casino)
  • Payroll records (e.g., is the employee paid by the tribal government or the casino)
  • Assigned Duties and Responsibilities (e.g., are the employee’s assigned duties and responsibilities primarily related to a commercial or a governmental activity of the tribal government)

However, it appears – based on the following examples set forth in the Notice – that the IRS intends to treat the “the “payroll records” factor and the “assigned duties and responsibilities” factor as potential trump cards.

  • A security guard assigned to provide security at a casino and on the casino payroll would be treated as a commercial employee.

(The Notice suggests that the result could be different – depending on his/her assigned duties and responsibilities – if the security guard were not on the casino payroll.)

  • A cashier on the payroll of a convenience store would be treated as a commercial employee.
  • A bookkeeper whose assigned duties and responsibilities are to maintain the books and records of a tribal hotel would be treated as a commercial employee even though he/she works in a government building and is on the payroll of the tribal government.
  • The tribe’s chief financial officer is classified as a governmental employee because his assigned responsibilities and duties are for a government activity, even though he/she temporarily (over a six-month period) spends a substantial amount of time working on the financing of a tribal casino.
  • A tribal police officer working from a police station in a tribal government building is a government employee even though he/she “occasionally” goes to the tribe’s casino while on patrol to restore order.
  • A tribal attorney working in a government building, and on the payroll of the tribal government, would be treated as a government employee even if the attorney is assigned principally to review the operations of a tribal marina so long as the attorney’s duties and responsibilities focus on compliance with tribal rules and regulations (i.e., a government oversight role).

Effective Date and Transition Relief Matters

The IRS anticipates that the potential guidance under consideration would not be effective any earlier than six months after publication of final regulations. A reasonable good faith standard would apply until the effective date. See Notice 2007-67. Pursuant to Notice 2006-67, current plans of Indian tribal governments are permitted to provide benefits to both commercial employees and government employees. However, such a “mixed ITG plan” would need to take corrective action once the regulations were finalized, including retroactively establishing a separate plan for commercial employees. The Notice also warns that continued relief under the “reasonable good faith” standard is available only if government plan benefits are not higher than commercial plan benefits.

Preliminary Assessment of the Proposed Guidance

The proposed guidance and the IRS’s plan to conduct tribal listening sessions as well as solicit public comment indicate that IRS is trying its best to interpret a difficult set of statutory provisions. However, the resulting proposed guidance (as described in the Notice) makes it clear that

  • no interpretation of Section 906 of the Pension Protection Act will put tribal government plans on a level playing field with state and local government plans
  • the commercial vs. governmental distinction will likely impose a crushing administrative burden on tribal government plan sponsors, and will likely discourage tribal governments from maintaining governmental plans for any of its employees

As noted in Holland & Knight’s Alert, “ACT Report Details Three Options for Distinguishing Between Governmental and Commercial Retirement Plans“ (September 8, 2011), the “IRS has been handed an impossible task of fixing a broken statute, one that Congress should ultimately amend.” Although Indian tribal governments should take advantage of the opportunity to work with IRS to further improve the guidance interpreting the provisions of Section 906, they may also want to lay the groundwork for its repeal by Congress.