Law Seminars International:
Tax Management for Tribes
February 21-22, 2008
Seattle, WA
The New Era of Increasing IRS
Audits of Tribal Governments:
Procedural Matters and Hot Issues
Mary J. Streitz
Dorsey & Whitney LLP
IRS Has Multiple Functions
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•
Education and outreach
•
Enforcement
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Compliance checks
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Audits – IRS often refers to these as “examinations”
–
Collection activities
Increasing IRS Emphasis
on Enforcement
• Emphasis is system wide, not just in Indian country
• IRS Office of Indian Tribal Governments (“ITG”) has
informed tribes in the Pacific Northwest that it currently
has over 120 open audits
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Compliance Check
• A review to determine whether the Tribe is adhering to
various tax return, information reporting, and
recordkeeping requirements
• Not an examination of books and records to determine
the correct tax liability for a past period
• Participation is optional
• Tribes can perform a self-compliance check through
ITG’s “TEFAC” program
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Audit
• An examination of the Tribe’s books and records to
determine the correct tax liability for a past period
• I.R.C. § 7605(b)
– no taxpayer shall be subject to “unnecessary
examination or investigations”
– “only one inspection of a taxpayer’s books of account
shall be made for each taxable year” unless appropriate
IRS personnel notifies the taxpayer in writing that an
additional inspection is necessary
• ITG specialists conduct these audits, except Bank
Secrecy Act audits and tax-exempt bond audits
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Preparing for an Audit
• Locate relevant records
– Retain copies of returns and backup documents for at
least 4 years after due date
• Identify sensitive factual issues
• Identify and evaluate exposure items
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Managing the Audit
• Time and place of audit
– Tribe is entitled to reasonable notice
– IRS is likely to want to commence audit at Tribe’s
facilities
– It may be helpful to discuss the scope and timetable for
the audit at the initial meeting at the Tribe’s facilities
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Managing the Audit (cont’d)
• Ground rules
– Specify personnel authorized to deal with IRS
• Limited group desirable
• IRS must make special arrangements to speak with
other Tribal personnel
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Managing the Audit (cont’d)
• Ground rules (cont’d)
– Ask that all IRS requests for information and
documents be made in writing
• These requests are known as Information
Document Requests (“IDRs”)
• Respond to IDRs in writing
• Keep records of correspondence and documents
provided
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Managing the Audit (cont’d)
• Role of counsel
– Assist in preparation
– Draft or review responses to IDRs
– The team member who says “no”
– Review notices of proposed adjustment and draft
responses
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Scope of the Audit
• Information and documents requested should be relevant
to some proper investigative purpose relating to
determining the correct federal tax liability of the Tribe or
a third party dealing with the Tribe
• Personal interviews
– ITG generally wishes to commence the audit with an
interview of a knowledgeable Tribal employee
– Tribe’s counsel may be present for interviews of
employees and agents of the Tribe
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Scope of the Audit (cont’d)
• Documents
– Financial records
– Tribal government records
– Attorney/client and other privileges protect certain
documents from disclosure
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The Audit Process
• IDRs
• Notice of proposed adjustments
• Request for technical advice from IRS National Office
• Settlement
– IRS examining agents generally have no ability to
compromise issues based on hazards of litigation
– Issues may be eliminated, however, if parties agree on
the merits
• 30-day letter and report on unagreed issues
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Contesting Unagreed Issues
After the Audit
• IRS Appeals Office
– File protest within 30 days after date of 30-day letter
– Informal process with one or more face to face
conferences, lasting up to a year or more
– Appeals Office mission is to settle cases on a fair and
impartial basis by taking into account hazards of
litigation
• Litigation in U.S. Tax Court, U.S. District Court, or U.S.
Court of Federal Claims
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Impact of Audit on Tax Liability
of Tribal Members
• Proposed adjustments for Tribe may lead to proposed
adjustments for tribal members
• Tribe may wish to coordinate resolution of tribal
members’ cases through a group-wide audit and appeals
process, with common legal representation if appropriate
– Assists tribal members with difficult process
– Ensures strong and consistent arguments will be made
– Efficient use of resources
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Audit Issues:
Employee v. Independent Contractor
• Who is an employee?
– IRC § 3121(d)(2) – “any individual who, under the usual
common law rules applicable to determining the
employer/employee relationship, has the status of an
employee”
– Common law test: whether employer has right to control
and direct the individual regarding the job s/he is to do
and how s/he is to do it
– ITG focuses on factors related to (1) behavioral control,
(2) financial control, and (3) relationship of the parties
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Audit Issues:
Employee v. Independent Contractor
• ITG takes the position that in general, members of
tribal boards and committees are employees, not
independent contractors
– See Example 3 from ITG’s Employment Tax Desk Guide, p.
12:
Ms. Fran is a tribal member but not a council member. Ms. Fran is on the
Beautification Committee. She is required to attend the Ms. Indian Pageant
Committee and is paid $50. Ms. Fran is considered an employee and is
subject to withholding of federal income taxes, FICA, and Medicare tax. Ms.
Fran will also be issued a Form W-2.
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Audit Issues: Section 530 Relief
• Section 530 of 1978 Revenue Act, as amended,
essentially overrides the common law rules
regarding worker classification for federal
employment tax purposes
– This statute is not codified in the Internal Revenue Code
– Section 530 provides retroactive and prospective relief
from employment tax liability to employers who
misclassified workers as independent contractors
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Audit Issues: Section 530 Relief
• Prerequisites for Section 530 relief (summarized in
IRS Publication 1976):
– Reasonable basis for not treating workers as employees
• Reasonable reliance on court case or IRS ruling;
• IRS did not reclassify workers in a previous audit;
• Reliance on practice by a significant industry segment; or
• Other reasonable basis
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Audit Issues: Section 530 Relief
• Prerequisites for Section 530 relief (cont’d):
– Substantive consistency
• Must have consistently treated workers, and any similar
workers, as independent contractors
– Reporting consistency
• Must have filed all required tax returns (i.e., Forms 1099-MISC)
consistent with treatment of workers as independent
contractors
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Audit Issues: Section 530 Relief
• IRS should consider eligibility for Section 530 relief
before examining the merits of the issue
• Section 530 provides one potential basis for
overriding ITG’s position regarding classification of
tribal board and committee members
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Audit Issues
• Distributions to tribal members
– Per capita payments
– Deferred per capita payments
• Programs for minors
• Programs for adults
– Nontaxable general welfare benefits
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General Welfare Doctrine: General
Tax Principles
• Section 61 of the Internal Revenue Code: all income,
from any source, is subject to taxation unless excluded
by law.
• Squire v. Capoeman, 351 U.S. 1, 6 (1956) & Rev. Rul. 67284: unless a treaty or law provides an exemption, all
tribal member income is taxable income, including nongaming per capita payments received from tribe
• IGRA: all gaming revenue per capita payments are
subject to federal income tax, reporting and withholding
• “General Welfare Doctrine”: certain benefits provided by
a tribe to its members may be nontaxable if they satisfy
the general welfare doctrine of federal tax law.
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General Welfare Doctrine
The IRS has broadly described the contours of its
general welfare doctrine and applied it to tribal
benefits:
“[P]ayments made under legislatively provided
social benefit programs for promotion of the
general welfare are excludable from gross
income. This general welfare doctrine applies
only to governmental payments out of a welfare
fund based upon the recipients’ need. . .”
Tech. Adv. Mem. 9717007 (Jan. 13, 1997)
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General Welfare Doctrine
• Facts and circumstances test
• Doctrine is driven by policy considerations
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General Welfare Doctrine
State/federal nontaxable general welfare benefit
programs:
– Benefits to the blind (Rev. Rul. 57-102)
– Crime victim compensation awards (Rev. Rul. 74-74)
– Grants to low income families for home ownership
(Rev. Rul. 75-271)
– Grants to help with basic needs in major disaster
(Rev. Rul. 76-144)
– Heating cost assistance for elderly and disabled
(Rev. Rul. 78-170)
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General Welfare Doctrine
Favorable IRS rulings involving tribal programs:
– Federal and tribal business development grants
(Rev. Rul. 77-77 and Priv. Ltr. Rul. 199924026
(Mar 19, 1999))
– Education benefits, based on members’ education
need, not financial needs (Tech. Adv. Mem.
200035007 (May 23, 2000))
– Education benefits, based on members’ financial
needs (Priv. Ltr. Rul. 200409033 (Nov. 24, 2003))
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General Welfare Doctrine
Favorable IRS rulings involving tribal programs:
– Housing benefits similar to those provided under
federal programs to low and moderate income
persons (Chief Counsel Advice 200138007
(Sept. 21, 2001))
– Housing benefits provided based on “a
consideration of financial as well as housing needs”
(Priv. Ltr. Rul. 200336030 (Jun. 6, 2003))
– Housing benefits provided based on a needs-based
priority system (Priv. Ltr. Rul. 200632005 (Apr. 13,
2006))
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Creating Nontaxable General Welfare
Doctrine Programs
General Characteristics:
• Tribal legislative body authorizes the program
– A written program document should explain need for program
and define eligibility criteria
– Tribal departments or committees with responsibility for
program administration may adopt program procedures
• Benefit program must be “need-based”
– Income eligibility rules most defensible
– Exceptions may include education, health-related benefits,
benefits for the elderly, and certain types of housing benefits
• Program open to every tribal member who qualifies
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Creating Nontaxable General Welfare
Doctrine Programs
Program document also should include:
 Dollar limit or other limits on benefits
 Required use of benefits, with safeguards against
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misuse
Priority rules
Application process
Review of program operations
Penalties for program violation
Appeal process
Program audit requirements
Creating Nontaxable General Welfare
Doctrine Programs
Program must be followed as closely as possible
• Adopt a program that the tribe can live with
• Provide for regular internal audits, with prompt correction
of problem areas, and external audits if necessary
Program should be amended infrequently and then
only if and to the extent necessary
If there are multiple programs, conduct a program
review to identify areas of overlap and inconsistency
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Creating Nontaxable General Welfare
Doctrine Programs
Decide whether to seek a private letter ruling from
the IRS National Office that the benefits paid
under the program are nontaxable under the
general welfare doctrine and not subject to
reporting or withholding
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Other Audit Issues
• Compensation paid to Tribal Council members
• Compensation paid to treaty fishery employees
• Tax exempt bonds – “essential governmental function”
test
• Scope of Bank Secrecy Act audits
• ITG has published its own “top 10” list of problems
discovered during compliance checks – see attachment
to materials
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IRS Guidance Projects
• Regulations establishing criteria for determining whether
a corporation is an integral part of the federal, state, or
tribal government
• Implementation of tribal government provisions of
Pension Protection Act of 2006
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