IRS considers removing restrictive tribal tax code

WASHINGTON – Tribes have long asked for it, now they may have a chance. The Treasury Department and Internal Revenue Service are contemplating whether to remove and improve tax code provisions that have long hampered tribal economic growth.

Treasury in July sent out a request for comment on several questions involving tribal tax issues and the possible repeal of what’s called the “essential governmental function” standard for tax-exempt governmental bond financing by Indian tribes under Section 7871 of the Internal Revenue Code.

Tribes were given until Sept. 10 to officially submit comments, and many are now lobbying Treasury officials behind the scenes to help them understand why a repeal should occur.

The technicalities involve complex tax code, but the situation can be boiled down to simple terms: Tribes have long been restricted in their participation in certain federal tax incentive programs. With the enactment of the stimulus funds of 2009, some of the rules were changed, so more tribes could hypothetically participate.

However, due partially to the economy, tribal incentives have largely gone stale. Plus, federal technicalities, including the “essential governmental function,” which the IRS has interpreted as a ban on certain projects that it believes to be commercial in nature, have made tribal participation slow.

Tribes are also largely prohibited from issuing “private activity bonds,” another funding tool other entities have been able to use for economic growth.

Lawyer Russ Brien, owner of Brien Law, LLC, said the tax code provisions have long been unfair to tribes. “Put together, the limits are more restrictive on tribes than those imposed on states and their political subdivisions.”

He noted that Tribal Economic Development Bonds were created under the American Recovery and Reinvestment Act of 2009 in an effort to alleviate some of the bonding issues facing tribes.

But success has been elusive.

“Although there are several contemplated transactions, I am not aware of any such bonds having actually been issued,” Brien said. “The deadline for issuance of the first $1 billion allocation is Dec. 31, 2010. Failure to issue by that deadline results in forfeiture of the allocation.”

Regarding that sunset provision, the Dorsey and Whitney law firm asked in a recent issue of a paper dedicated to tribal tax code issues: “How can tribes work together to use allocations previously awarded for projects that continue to be viable in part but not viable in part?”

The stimulus law requires Treasury to conduct a study this year on TEDBs and report back to Congress with recommendations regarding their use.

Gavin Clarkson, a leading tribal finance expert with the University of Houston Law Center, highlighted the very real economic implications of muddled tribal tax code in a 2007 North Carolina Law Review article, writing, “Upwards of $50 billion in capital needs go unmet each year in Indian country in such vital sectors as infrastructure, community facilities, housing, and enterprise development, in part due to the restrictions imposed on tribal access to the capital markets, specifically the ability of tribal governments to issue tax-exempt debt.”

He said the restrictions have severely limited tribal abilities to access the capital markets, and although American Indians make up more than 1.5 percent of the population, tribes issued less than .1 percent of tax-exempt bonds between 2002 and 2004.

Tribal financial experts believe the IRS restrictions tend to harm poorer tribes most, as the differential between tax-exempt and taxable interest rates often determines the feasibility of a project.

“Without access to tax-exempt rates, poorer tribes simply cannot afford the debt service required to address glaring economic and infrastructure deficiencies,” Clarkson wrote.

Compounding the problems, tribal officials have long noted that their governments have faced a disproportionate number of enforcement actions by the IRS.

Clarkson said the IRS audits less than 1 percent of the tax-exempt municipal offerings each year, but direct tribal tax exempt issuances are 30 times more likely to be audited within four years of issue than city and state issuances.

“In each of these cases, the tribes financed activities that had previously been routinely financed by state and local governments without any challenge from the IRS.”

Many tribes have brought up the discrepancies with the IRS, hoping for change. Final consideration from Treasury on tribal tax code issues are expected later in the year.


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IRS considers removing restrictive tribal tax code