Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647)

Indians generally are subject to Federal income tax like other U.S. citizens, absent a specific Federal exemption. Consequently, the Tax Court has ruled in three cases that income derived by Indians from protected fishing activities is taxable, and the Internal Revenue Service has assessed deficiencies in other cases.

As amended, H.R. 2792 would clarify application of the income tax laws to income derived by certain Indians and Indian-owned entities from the exercise of fishing rights protected by treaties, acts of Congress, or executive orders. Such income would not be subject to Federal, State, or local income taxes, including social security taxes. Income of individual Indians and qualified Indian entities would be tax exempt to the extent it was derived from the exercise of rights granted the tribe of which (1) the individual was a member or (2) the owners of the entity were members. Both individual tribal members and qualified Indian entities would be required to allocate income and expenses among fishing rights-related activities and other activities.

Questions have been raised whether a special tax rule should apply to income earned by members of certain Indian tribes from the exercise of fishing rights guaranteed by treaties, Federal statutes, and executive orders. The treaties at issue, most of which were entered into the latter half of the 19th Century before adoption of the 16th Amendment pursuant to which the Federal income tax is imposed, generally secure to Indians who had relinquished all rights to large areas of land (mostly in the West and Great Lakes regions) the exclusive rights to fish on reservation property and the shared rights to fish off-reservation property at "all usual and accustomed grounds and stations."⁴

The fishing rights reserved to Indians include the right to fish for subsistence as well as for commercial purposes. In addition, certain hunting, gathering, and grazing activities are also secured to Indians by treaties, Federal statutes, and executive orders.⁵

The treaties, Federal statutes, and executive orders that reserve fishing rights to Indians do not contain provisions that specifically address the issue of Federal income taxation of Indian fishing activities. Consequently, the Tax Court has ruled in three cases that income derived by Indians from protected fishing activities is taxable,⁶ and the Internal Revenue Service has assessed deficiencies in other cases.⁷

Federal tax issues

(secs. 1 and 3 of the bill, as amended, new sec. 7873 of the Code, secs. 1402(a) and 3121(a) of the Code, and secs. 209 and 211(a) of the Social Security Act)

In the case of a self-employed member of an Indian tribe having protected fishing rights, the bill provides that income earned by that individual from fishing rights-related activity is exempt from Federal income taxes and from Federal social security (SECA) tax. Income earned by a corporation, partnership, or other business entity from fishing rights-related activity also is exempt from Federal income taxes if the entity constitutes a "qualified Indian entity," as defined in the bill.⁸ Wages to a tribal member employed by another tribal member or by a qualified Indian entity from income derived from fishing rights-related activity are exempt from Federal income taxes, from both the employers' and employees' share of social security (FICA) tax, and from unemployment compensation (FUTA) taxes.⁹ Wages are not exempt from tax under the bill if paid by an employer who is not a tribal member or qualified Indian entity, or if paid to an employee who is not a tribal member.

A qualified Indian entity may be jointly owned by members of more then one Indian tribe, provided that the entity is engaged in fishing rights related activity of each tribe of which the owners are members. If a jointly owned entity engages in substantial processing or transporting of fish, at least 90 percent of the annual gross receipts must be derived from fishing-rights related activities of tribes whose members own at least 10 percent equity interests in the entity.

An entity that fails to satisfy any of the criteria of a qualified Indian entity is not eligible for the exemption from tax provided by the bill, nor is any employee of such an entity eligible under the bill for tax exemption on wages received from such entity. For example, if an entity receives more than 10 percent of its gross receipts in a taxable year from processing fish not harvested by tribal members exercising protected fishing rights, then the entity does not constitute a "qualified Indian entity" for that year, and the entity's income and wages and distributions paid by the entity are not entitled to exemption under the bill. In contrast, if an entity processes fish but 90 percent or more of its annual gross receipts is attributable to fish harvested by tribal members exercising protected fishing rights, then, provided that the entity meets the ownership and management tests, the entity would constitute a qualified Indian entity for that year.

If an entity that is 100 percent owned and managed by tribal members engages solely in harvesting (and selling) of fish, then the entity would be a qualified Indian entity, regardless of the percentage of its annual gross receipts attributable to fish not harvested through the exercise of protected fishing rights. (As with entities engaged in processing or transporting fish, such an entity's income is tax exempt, however, only to the extent it is derived from fishing rights-related activities, as determined pursuant to the allocation rules discussed below.)

If, for example, an individual tribal members derives 60 percent of his or her gross income in a taxable year from fishing in protected waters and the remaining 40 percent of his or her gross income from fishing outside of protected waters, then 60 percent of the member's income would be exempt from tax under the bill, and any expense (e.g., operating expenses or depreciation) attributable to such exempt income could not be used to offset gross income derived from fishing outside protected waters or any other income.¹⁶

Allocation rules also would apply to income earned, and wages paid, by a qualified Indian entity. Thus, a 100-percent Indian owned and managed entity that engages solely in harvesting and selling the fish it harvests or that engages in processing (or transporting) fish and obtains at least 90 percent of its annual gross receipts from fishing rights-related activities, would constitute a qualified Indian entity, but would be entitled under the bill to an exemption from tax only with respect to income attributable to harvesting or processing of fish caught in protected waters by tribal members. Expenses and amounts otherwise deductible that are attributable to such exempt income of the entity could not be used to offset any other income of the entity.

In the case of qualified Indian entities that are jointly owned by members of more than one tribe, wages paid to a tribal member who is an employee (or a distribution made to a shareholder who is a tribal member) would be exempt under the bill only to the extent the income was derived from the exercise of fishing rights of the employee's or owner's tribe. For example, if a qualified Indian entity were jointly owned by members of Tribe A and members of Tribe B, then the entity's income would be exempt to the extent it was derived from the exercise of fishing rights-related activities of Tribe A or Tribe B, but wages (or dividends) paid to an employee (or owner) who is a member of Tribe A would be tax-exempt to that individual only to the extent derived from the exercise of fishing rights guaranteed to Tribe A. Income derived from the exercise of fishing rights guaranteed to Tribe B (or from fishing activities not within the scope of a treaty, Federal statute, or executive order) would not be exempt when paid as wages (or a dividend) to a member of Tribe A.

The committee intends that the Treasury Department may adopt regulations providing any reasonable method for allocating wages paid to a tribal member employed by another tribal member or by a qualified Indian entity between wages attributable to the employer's income derived from fishing rights-related activity and wages attributable to other activities. The allocation method could be based, e.g., on the particular activities engaged in by each individual employee or on the employee's pro rata share of the employer's gross income from fishing rights-related activity. Some of these rules should address the extent to which income of owners and employees of entities jointly owned by members of more than one tribe is allocable to the exercise of fishing rights of each of the tribes whose members own or are employed by the entity.

H.R. 2792 governs only the tax treatment of income derived from the exercise of fishing rights guaranteed by treaties, Federal statutes, or executive orders, and no inference is made that income derived from any other activity guaranteed to Indian tribes by treaties, Federal statutes, or executive orders (e.g., hunting, gathering, or grazing activities) is exempt from taxation.¹⁷

State tax issues

(sec. 2 of the bill, as amended, and 25 U.S.C. 71)

The bill also amends the United States Code (28 U.S.C. 71) to provide that treaties, Federal statutes, and executive orders under which the rights of any Indian tribe to fish are secured, shall be construed to prohibit imposition under State or local law of any tax on income derived from the exercise of such rights to fish if the income is exempt from tax under Federal law. However, to the extent that the exercise of fishing rights of any Indian tribe is entitled to a broader exemption from State taxes under any other Federal or State law, the committee intends that the bill not impair this additional protection afforded Indian fishing activity.¹⁸

The bill as amended by the committee is estimated to reduce fiscal year budget receipts by $8 million annually for 1988-1992.

The Subcommittee on Select Revenue Matters of the Committee on Ways and Means held a hearing on H.R. 2792 on December 14, 1987, and approved the bill with an amendment on March 17, 1988. On June 9, 1988, the Committee on Ways and Means marked up the bill and ordered the bill favorably reported with an amendment in the nature of a substitute.

H.R. 2792 was jointly referred to the Committee on Interior and Insular Affairs and the Committee on Ways and Means. The bill was favorably reported by the Committee on Interior and Insular Affairs on September 21, 1987 (H. Rpt. 100-312, Part 1).

² See, Squire v. Capoeman, 351 U.S. 1 (1956) (holding that gains from sale of timber on lands allotted to noncompetent Indians but held in trust by the United States pursuant to the General Allotment Act of 1887 was exempt from Federal income taxes).

³ See, Choteau v. Burnet, 283 U.S. 691 (1931) (income of competent Indian, who had unrestricted control over lands, held to be subject to tax); Superintendent of Five Civilized Tribes v. Comm'r, 295 U.S. 418 (1935) (income derived from reinvestment of surplus income from land held to be subject to tax). See also, Fry v. Comm'r, 557 F.2d 646 (9th Cir. 1977) (taxing income from logging operation on reservation land); and United States v. Anderson, 625 F.2d 910 (9th Cir. 1980) (taxing income from cattle ranching on reservation land).

⁴ See, Washington v. Washington State Commercial Passenger Fishing Vessel Assoc., 443 U.S. 658, 662 (1979). Some of these treaties secure to Indian tribes the opportunity to catch up to 50 percent of the harvestable numbers of fish passing through their traditional fishing areas. Id. at 685.

⁵ See, Antoine v. Washington, 420 U.S. 194 (1975); Mattz v. Arnett, 412 U.S. 481 (1973). Since 1871, when Congress prohibited further treaty making with Indian tribes, the usual method of dealing with Indian tribes and establishing reservations has been either by statute, executive order, or agreement later approved by an Act of Congress, See, H. Rpt. 100-312, Part 1, at p. 2.

⁶ See, Peterson Estate v. Comm'r, 90 T.C. No. 18 (February 11, 1988); Earl v. Comm'r, 78 T.C. 1014 (1982); Strom v. Comm'r, 6 T.C. 621 (1946), aff'd per curium, 158 F.2d 520 (9th Cir. 1947).

Prior to the most recent Tax Court decision, however, the Department of Interior had taken the position that treaty or statutory language that reserves fishing rights to Indians precludes Federal taxation of income derived from the exercise of those rights, because otherwise the tax, in essence, would be a charge imposed upon Indians for exercising their fishing rights that was not contemplated at the time the rights were reserved. See, memorandum from Frank K. Richardson, Solicitor for the Department of Interior, to the Secretary of the Interior, dated March 12, 1985.

⁷ In a letter to Senator Daniel J. Evans (R., Washington), dated May 12, 1987, the IRS stated that it will not pursue collection of tax on income derived by Indians from the exercise of protected fishing rights pending consideration of legislation to exempt that income.

⁸ The exemption from tax applies to direct income received by a taxpayer as well as to distributions with respect to an equity interest in a qualified Indian entity to the extent the distribution is attributable to income derived by the entity from fishing rights-related activity.

⁹ Exemption of FICA (and SECA) and FUTA taxes has the corollary effect that the wages (and income) are not taken into account in computing social security benefits and unemployment compensation.

¹⁰ Only fishing rights secured as of March 17, 1988, by a treaty, Federal statute, or executive order are covered by the exemption provided for by the bill. Although the fishing right must have been in existence as of March 17, 1988, it need not have been formally adjudicated or recognized as of that date.

¹¹The committee intends that the rules for determining tribal membership not be expanded significantly by tribes to encompass individuals who do not qualify as tribal members under rules in effect on March 17, 1988.

¹² Ownership of interests by spouses of tribal members is disregarded for this purpose.

¹³ In this context, "transporting" means the shipment of fish for profit as a separate commercial activity and not the mere carrying of fish from waters where they are harvested to the point of sale or processing.

¹⁴ While the determination whether an entity is a qualified Indian entity normally is made on a yearly basis, the committee intends that the Treasury Department may continue to treat entities as qualified Indian entities under the bill in a year in which the 90-percent test is not satisfied solely by reason of extraordinary and nonrecurring events, such as the sale of a boat or other property.

¹⁵ However, allocations between exempt and taxable income would not be required where all but a de minimis amount of the income of the individual or entity was derived from protected fishing activities.

¹⁶See, Code section 265.

¹⁷ The bill does not affect the income of a tribal government received pursuant to the exercise of an essential governmental function. (See, Code sections 115 and 7871, and Rev. Rul. 67-284, 1967-2 C.B. 55, 58).

¹⁸ For instance, income earned by Indians from activities undertaken on a reservation generally are exempt from State taxation. Thus, income earned by an Indian or Indian-owned entity from harvesting or processing fish within reservation boundaries would be exempt from State taxation, regardless of whether the requirements of the bill for exemption from Federal tax are satisfied.