Born and raised in India, experiencing self-governance firsthand through “Panchayats” in rural India that grapple with the issues of rural health, welfare, education, unemployment, corruption, irremediable factional politics and corrosive struggle for power and control of resources, and environment, American Indian societies in the United States hold a special place for me. I set out to learn more about this unique community of estimated 4.2 million members, their system of self-governance and earnest quest for promoting general welfare of the community while preserving their special heritage, culture, and language. This blog post is in a series of posts addressing tax, financial and investment management issues affecting this strikingly unique and special society.
As Indian Gaming Weekly (July 17, 2012) noted, Indian Gaming was born in 1979, recognized by the United States Supreme Court in 1988 with its landmark decision in California vs. Cabazon Band of Mission Indians. In relatively short history of operations, Indian Gaming today has emerged a sound and stable source of revenue for the Indian societies. In the same issue, Indian Gaming Weekly notes that Indian Gaming generated over $26 billion in revenue; in 2009 paid $9.4 billion in federal tax and $2.4 billion in state and other taxes; provides 628,000 jobs across the United States, and currently 246 tribes operate 460 gaming facilities in 29 states (http://indiangamingweekly.com/latest-indian-casino-facts/). The tables below highlight Indian Gaming revenue by key states, with California leading the pack:
Sources: Howard Stutz, Las Vegas Review-Journal, May 6, 2012
Indian Gaming is a heavily regulated activity supervised at the tribal government level, and by federal and state regulatory bodies. Federal law, 25 USC §2710(b)(2)(B), sets out rules for the specific use of the Class II and Class III gaming revenue. It can be used solely for five functions:
- Tribal government operations or programs.
- General welfare of the Indian tribe and its members.
- Promotion of tribal economic development.
- Donation to charitable organizations (a category to be discussed in a separate blog post).
Funding of operations of local government agencies.
Although most gaming tribes (estimated to be three-fourths of gaming tribes) consume all gaming revenue for funding governmental operations and promoting general welfare of the tribal members. A few gaming tribes (one-fourth) make per capita payments out of their gaming income to their members. The per capita payments allocated to minor members of the tribes are a primary focus of this post.
These per capita payments are subject to Federal taxation (25 USC §2710(b)(3)(D). Thus adult members of the tribes receive per capita payments and currently pay applicable income tax as any other taxpayer. But what about the payments allocable to the minor members of the tribes? Federal governing law (25 USC §2710(b)(3)(C)) directs the tribes to protect and preserve interest of minor members entitled to these per capita payments. Tribes have addressed this obligation haphazardly and in an ad hoc manner by placing minors’ share in their respective custodial accounts (exposing the payments to current taxation at the parents’ tax rates, as the funds are in fact constructively received by the minors), seeking tax deferral by placing the payments in defective minors’ trusts that do not fully company with the deferral rules, ineptly and inefficiently managing the comingled funds placed in the minors’ trusts.
Revenue Procedure 2003-14
The Internal Revenue Service (IRS), in Revenue Procedure 2003-14, provides a safe harbor mechanism for ensuring tax deferral of per capita payments to minors so long as the trust instrument incorporates the following key requirements:
- The Indian tribes complies with the per capita disbursement requirements of 25 USC §2710(b)(3).
- All contributions to the trust are only the minors’ per capita amounts.
- Each minor trust beneficiary is the member of the Indian tribe.
- Each member is a minor (or legal incompetent) and contributions are made during the period the member is a minor.
- The trust is a valid trust under the applicable state and tribal law.
- The trust is a “grantor” trust under the tax code and the tribe is the grantor.
- The tribe has sufficient power or interest or the combination of the two to be treated as owner of the trust.
Certain governance and distribution provisions to avoid constructive receipt and current taxation:
- Unavailability of trust assets to the minors (except for certain discretionary distributions under a preapproved plan) until the beneficiary ceases to be a minor.
- Except for unsecured claim against the Indian tribe, the beneficiary has no preferred claim or beneficial ownership of funds.
- Freezing distribution during the period the tribe is insolvent or under bankruptcy proceedings.
- Trust funds cannot be anticipated, assigned, pledged, encumbered, or subject to levy, garnishment, etc.
Certain provision of a structured distribution of minor’s interest in case of death of the minor.
- More importantly, provision for distribution to the minor upon minor ceasing to be a minor in lump-sum or at specified age or ages or upon occurrence of a specified event(s).
These provisions in practical terms are not so onerous and the last one provides some opportunity for creativity by allowing staggered payments rather than a lump-sum amount that could trigger high marginal tax rate. For example, PLR 200022048, issued on June 2, 2000, allowed the following schedule of distribution:
|At Age||% of Account Balance|
Similarly TAM 200106007, issued on February 9, 2001, sanctioned a graduated distribution schedule linked to various age levels. It appears that the concepts of these rulings are now incorporated in the above-listed requirement 9 of Rev. Proc. 2003-14.
For an excellent discussion of Minors’ trust issues, see Kathleen M. Nilles and Telly J. Meier, Does Your Tribe’s Minors’ Trust Need a Tune-Up, http://www.nafoa.org/pdf/HK-Minors-Trust-Update.pdf. For general policy and governance issues of Indian tribes, see The Harvard Project on American Indian Economic Development at http://hpaied.org.
Governance and Investment Management Issues
An Indian tribe’s creating a minors’ trust and funding it in a disciplined manner are only part of providing a jumpstart to its minors’ lives and improving wellbeing of American Indian societies. Management of the funds, asset allocation, selecting an ethical and highly respected financial institution, free of conflicts and self-dealing, for investment of the funds that optimally balance demographics of the minor population, risks and returns, and minimal operating cost are equally important issues that may be overlooked or ineptly addressed. When it comes to managing minors’ trust’s funds, all internal politics must cease as shaping the destiny of the future generation is at stake. Depending on the demographic profile of minor beneficiaries of the trust, appropriate risk tolerance level, expense control, better oversight, as a way of illustration, a principal balance of say $3 million today grows to $5.58 million after 21 years at 3% rate of return; to $8.58 million at 5.13% realized rate of return. But higher returns in part come by assuming higher level of risk. What risk level is appropriate when time horizon is long, devising an appropriate asset allocation and investment management policy, periodically updating it as the circumstances warrant, are very difficult but incredibly rewarding decisions. Unrelated to the trust issues, should tribes inform and educate its members as to other means of tax deferred savings for funding post-secondary education of its members, such as 529 Plans. A separate post will cover these topics.