Tax Treatment of Tribal Governmental Benefits Programs

By Kathleen M. Nilles and Karen B. McAfee

We are often asked how Indian Tribal Governments may provide governmental services or benefits on a tax-free basis to tribal members. This memorandum outlines the available options and provides a general analysis of the expected federal tax treatment of such benefits.

Once an Indian Tribal Government ("Tribe") has determined the options it would like to implement, we frequently provide a formal legal opinion or request an Internal Revenue Service ("IRS") ruling, if needed, on one or more specific options. As noted below, the tax treatment of some benefit programs is unclear.

It is well established that tribes may provide tax-free benefits to their tribal members that are substantially similar to the types of benefits provided by federal, state, and local governments. These types of benefits could be provided under the following programs.

Educational Benefits Program: In-kind educational benefits may be provided to tribal members without regard to financial need under an educational benefits program. The types of benefits that could be provided include the following:

• a child development center to provide age-appropriate education for children from infancy through kindergarten;

• a tutoring program available to tribal youth and adult members to provide remedial instruction and assistance, such as assistance in obtaining high school general equivalency degrees;
• a summer youth program for children ages five to twelve who need care; and

• the payment of room and board at certain residential living schools for tribal students with learning disabilities and other special needs.

Scholarship Program: In addition to providing in-kind educational programs and benefits, a Tribe may wish to consider establishing a scholarship program. Under this program, the Tribe could award cash scholarships for tuition and related expenses of tribal members at public and private schools, colleges, and universities. "Related expenses" include amounts paid for fees, books, supplies, and equipment required for courses of instruction.

Health Benefits Program: Health benefits could be provided tax-free to tribal members without regard to financial need under a health benefits program. With respect to medical services, a Tribe could offer:

• medical, dental, and vision insurance to enrolled tribal members and their spouses and children;

• financial assistance with prescription drugs and/or medical, mental health, disease management, dental, and assisted living or nursing home services; and/or

• disease management services (which coordinate and support the treatment of individuals with chronic illnesses -- such as congestive heart failure, coronary artery disease, chronic obstructive pulmonary disease, diabetes, and asthma).

With respect to the mental health of tribal members, the Tribe could provide or offer financial assistance with mental health services such as:

• psychiatric and psychological assessment and diagnosis;
• individual theraphy;
• family, marital, and group psychotherapy;

• residential treatment programs for alcohol and substance abusers; and/or

• day treatment and residential treatment for individuals being treated for mental illness.

In addition, a Tribe could establish a fitness and nutrition center for use by tribal members.

General Welfare Programs: In general, payments made under legislatively provided social benefit programs for the promotion of general welfare are excludible from the recipient's income. To be considered general welfare payments, all payments made under a general welfare program must be based on "need" (such as, for example, financial status, health, educational background, or employment status) rather than made to all members of a tribe. Although the IRS generally looks to the low-income guidelines of federal programs to determine whether need exists, the IRS does not use a bright-line rule to determine "need" for general welfare payments. It appears that the requisite amount of "need" also may be established where individuals are not necessarily within the low-income guidelines of federal programs, but have extraordinary expenses (such as medical bills) to justify payments for their assistance.

• Educational Assistance Programs: In addition to the educational programs listed above, a Tribe may also wish to consider establishing an educational assistance program under which payments for room, board, and living expenses may be made to tribal members attending colleges, universities, and certain boarding schools. Although private payments for these types of educational assistance are generally taxable, the IRS has ruled privately that governmental payments for education based on need may be excluded from a recipient's income.

• Economic Development Programs: A Tribe may wish to consider establishing a business development program to encourage tribal members to own and operate business ventures on or near the reservation. Under this program, the Tribe could make grants to tribal members to assist them in establishing new businesses. To ensure that the grants are tax-free to the recipients, the recipients should be required to demonstrate that they could not obtain financing from other sources.

• Housing Assistance Programs: A Tribe may wish to consider establishing a housing assistance program. This program could include both housing and mortgage assistance and assistance with utility bills. Housing assistance payments made to low-income members of an Indian tribe have been held by the IRS to be in the nature of general welfare payments and not includible in the recipient's gross income.

• Mortgage assistance payments made under programs based on need have been held by the IRS to be in the nature of general welfare payments and not includible in the recipient's gross income.
• Maintenance assistance payments made to low-income homeowners have been held by the IRS to be in the nature of general welfare payments and not includible in the recipient's gross income.
• Utility assistance payments made by state governments to low-income elderly or disabled persons to reduce the costs of their winter utility bills have been held by the IRS to be in the nature of general welfare payments and excludible from the recipient's gross income.

• Elders Assistance Programs: A Tribe might wish to consider establishing an elders assistance program to provide financial assistance to certain low-income or disabled tribal elders. However, in order for payments under such a program to be tax-free, the program must be limited to tribal elders that demonstrate "need," either by satisfying federal low-income guidelines or having extraordinary medical or other bills.

"Spending Account" Approach is Not Workable: With regard to benefits, it should be noted that a "spending account" approach to health, educational, and other similar benefits will not yield the same tax benefits for tribal members. In 1997, the IRS issued a technical advice memorandum ("TAM") to a tribe that distributed cash payments to tribal members for them to use (as they saw fit) on certain "governmental program" expenses, including education, health and medical care, and retirement programs. The tribal members apparently were told that they could deduct any expenses for these or similar items from the otherwise taxable cash payments. The IRS determined, however, that the entire amount of the payments were taxable.

Governmental Programs For Which The Tax Treatment Is Uncertain In addition to the above, Tribes have established one or more of the following benefit programs. While we believe that there are good arguments that benefits provided under the following programs should be tax-free to tribal members, the federal tax treatment of such benefits is unclear at present.

Life Insurance: Some Tribes are considering whether they should provide life insurance to enrolled tribal members and/or their spouses and children. If the Tribe pays the premiums, the economic benefit to its members could be viewed by the IRS as taxable income.Burial Plot and Funeral Programs: Some Tribes have established a burial plot and funeral program for enrolled tribal members and their spouses and children. While there is no statutory exclusion for the tax-free treatment of benefits under such a program, there is a reasonable argument that providing such a program is an essential governmental program.

Social Security Benefits Programs: Several Tribes have expressed interest in providing social security benefits to elderly tribal members. There appears to be a good argument that payments made to tribal members under a system similar to Social Security should be tax-free. However, there is no clear authority on point.

Because the tax treatment of each of the above programs is unclear, we would recommend that a Tribe not implement such programs without seeking an IRS private letter ruling to confirm the desired treatment. Even if a private ruling has been issued to another taxpayer implementing an analogous program, such private ruling may only be relied upon by the taxpayer to whom it is issued.

Deferred Per Capita Plans: To provide for the maintenance of tribal members in their old age or in the event of a disability, a Tribe may wish to consider establishing a deferred per capita benefit plan. Under such a plan, a tribal member could elect to defer some portion of his or her per capita benefits. The deferred amounts would be deposited in a so-called "rabbi" trust. The IRS has ruled privately that amounts deferred under such a plan would not be subject to federal income tax until the year such payments are distributed or otherwise made available to the participants.

Deferred Income Plans: A Tribe may also wish to consider creating a deferred income plan to provide a source of revenue for future needs of the Tribe or its members. Under this type of plan, the Tribe could transfer property to a trust that would be held for the benefit of future tribal members. Provided that the trust is properly structured, amounts placed in the trust would not be currently taxable to tribal members. The IRS has ruled privately that amounts placed in a grantor-type trust would be tax-deferred.

There are a number of ways in which Indian Tribal Governments may provide various tax-free benefits to tribal members. There are also a number of ways in which the tax on tribal members' income may be deferred. Some governmental programs are required to be needs-based, while others face no such requirement under IRS administrative practice.

Copyright 2003 Gardner Carton & Douglas