- President Donald Trump on Dec. 22, 2017, signed the Tax Cuts and Jobs Act, the first major overhaul of the U.S. tax system in over 30 years.
- Although few of the enacted provisions are specific to Indian Country, several changes have real impacts on tribal governments and their members, including the reduction of individual tax rates, changes to the state and local tax deduction, and the treatment of the Kiddie Tax.
- This client alert provides an overview of six tax provisions impacting tribal governments and their members that deserve attention in 2018.
President Donald Trump on Dec. 22, 2017, signed the Tax Cuts and Jobs Act (Tax Act), the first major overhaul of the U.S. tax system in over 30 years. Although few of the enacted provisions are specific to Indian Country, several changes have real impacts on tribal governments and their members, including the reduction of individual tax rates, changes to the state and local tax (SALT) deduction, and the treatment of the Kiddie Tax. Further, several key benefits signed into law by the past administration remain available to tribal governments and their members. This client alert provides an overview of six tax provisions impacting tribal governments and their members that deserve attention in 2018.
1. Incentives for On-Reservation Housing and Home Ownership
Under the Tax Act, the SALT deduction for income and property taxes is now capped at $10,000 for joint and single filers. The limitation on SALT deduction may lead to increased interest in on-reservation home ownership, and provide an incentive for tribal governments to facilitate the purchase and construction of on-reservation housing because on-reservation homes are not subject to SALT. Further, per capita distributions made to on-reservation residents are exempt from state income taxes. While both of these exemptions existed under prior law, their benefit is magnified by the Tax Act's cap on the SALT deduction.
2. 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:
- it simplifies tax compliance by the minor members and their parents by deferring taxation until actual distributions are made
- 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)
- 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
In 2011, when the IRS finalized its minors trust guidance that included provisions allowing 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.
Restructuring minors trusts is especially important in light of changes made to the Kiddie Tax by the Tax Act. The Tax Act "simplified" the Kiddie Tax by applying the income tax rates generally applicable to estates and trusts to the net unearned income of an individual to whom the Kiddie Tax applies, instead of the rates of the individual's parents. This change in law will sharply increase the rate and overall amount of tax imposed on minors trust distributions, per capita distributions and other "unearned income" distributions made to minors and young adults who are subject to the Kiddie Tax. For example, a 19-year-old tribal member subject to the Kiddie Tax would owe $35,000 in taxes on a $100,000 minors trust distribution. The same individual would owe only $15,000 in taxes on the distribution if he or she was not subject to the Kiddie Tax.
(See Holland & Knight's Webinar, Indian Country and Tax Reform: What Happened, What's Next, and What Can We Do?, Jan. 18, 2018.)
3. Excludable Health Insurance and Health Benefits
Fortunately, Section 139D of the Internal Revenue Code survived both tax reform and efforts to repeal and replace the Affordable Care Act (ACA). This section was added to the tax code by the ACA and states that healthcare benefits provided by the Indian Health Service (IHS), a third-party program funded by the IHS, medical care purchased by the tribe or tribal organization, coverage under accident or health insurance and any other medical care provided by the tribe or tribal organization is excluded from the gross income of tribal members, and thus exempt from tax. In 2018, tribes who wish to provide healthcare benefits should ensure they are taking full advantage of this section.
4. Payments Pursuant to General Welfare Exclusion Programs
Section 139E of the Internal Revenue Code, enacted pursuant to the 2014 Tribal General Welfare Exclusion Act, specifically exempts payments made by an Indian tribe to its members, spouses and dependents of tribal members. This provision allows tribal governments to provide a wide range of excludable benefits ranging from education and housing to elder care and cultural programs. Under Section 139E, the exclusion applies as long as the tribal government program complies with the following requirements:
- it is administered under specified guidelines and does not discriminate in favor of members of the governing body of the tribe
- the benefits provided:
- are available to any tribal members (including spouses and dependents) who meet the government program's guidelines
- are for the promotion of general welfare
- are not lavish or extravagant
- are not compensation for services
To maximize the potential tax savings, a tribal program inventory should be undertaken to make sure that the tribe's 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.
The 2014 Tribal General Welfare Exclusion Act also required the creation of a Treasury Tribal Advisory Committee (TTAC). This new committee will, among other things, advise the Treasury Secretary on the taxation of Indians. Importantly, the U.S. Department of Treasury on Feb. 8, 2018, announced the final member of the TTAC, meaning this advisory committee can now begin to take a more active role.
(For more information and to access the most recent Internal Revenue Service (IRS) General Welfare Exclusion guidance, see Holland & Knight's alert, IRS Issues Guidance on Tribal General Welfare Exclusion and Safe Harbors, April 21, 2015.)
5. Distributions from Nontaxable Sources of Tribal Revenue
Almost all types of revenue are free from federal income tax when earned by an Indian tribe, but some also are free from tax when they are subsequently distributed to the tribe's members. Based on 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:
- income from leases, easements and other uses of federal trust land
- income from trust resources, such as timber, mineral deposits, oil and gas
- income from the sale of trust land or from damage awards related to trust land
- certain tribal trust case settlements with the United States pursuant to IRS Notice 2013-1 and recent updates, such as IRS Notice 2016-48
(See Holland & Knight's alert, Interim IRS Guidance Confirms Per Capita Distributions from Tribal Trust Resources Are Nontaxable, March 18, 2014, and IRS Confirms Per Capita Tribal Trust Payments Not Taxable, Sept. 21, 2015.)
6. Adopt a Deferred Per Capita Savings Plan for Elective Deferrals of Gaming Revenues
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 long-standing 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 be established by the tribe only, this is again a situation where tribal leaders can provide opportunities for tribal member tax savings. Deferred per capita plans are especially useful to the extent that they allow deferral of income from a year in which the member is subject to a high tax rate to a future year in which the income may be subject to lower rates.
Of course, there are many reasons, in addition to income tax savings, that a tribal member might voluntarily decide to defer a portion of a per capita payment, including:
- 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)
- as a hedge against a downturn in tribal gaming revenues
- 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.