Distributions of Casino Revenue Are Taxable to Native American Tribe Members

(Parker Tax Publishing May 2019)

The Tax Court held that members of a Native American tribe, who received distributions of revenue from a casino that is operated on tribal land and owned communally by all members, have to report that revenue as taxable income. However, the Tax Court rejected the IRS's imposition of penalties because the IRS did not obtain written supervisory approval before the first formal communication of its initial determination to assess penalties on the tribe members. Clay v. Comm'r, 152 T.C. No. 13 (2019).

The Miccosukee Tribe of Indians of Florida (Tribe) is a federal recognized tribe of Indians. The Tribe's day-to-day operations are controlled by the Business Council, which has five members, each elected to a four-year term by the General Council. The Tribe began operating a casino in 1990. In 1995, the Tribe began collecting a gross receipts tax on any amount received by the casino, including wagers, admission fees, and sales revenue from related enterprises.

The Tribe's finance director, Mike Hernandez, opened a checking account which he labeled as the nontaxable distribution revenue (NTDR) account. The Tribe deposited the gross receipts tax revenue from the casino into that account. Most of the funds in the NTDR account came from the casino, although the account also included revenue from the Tribe's small businesses and land leases and easements. The casino's net profits went to the Tribe's general bank account.

The Tribe has made quarterly per capita distributions to its members since at least 1989. Until 1995, the Tribe distributed funds to its members from its general bank account. The largest sources of this revenue were the Tribe's small businesses and land leases. Before the casino opened, the distributions were around $100 per member per quarter. The distributions increased considerably with the casino's success.

The Tribe has maintained since 1995 that its distributions are not taxable to members and need not be reported on their income tax returns. The chairman of the Business Council, Billy Cypress, advised Hernandez that the tribal attorney assured him that the distributions should not be reported on members' tax returns, and Cypress encouraged tribal members to cash their quarterly distribution checks at the tribal administration office and to omit the distributions from credit applications to avoid inviting scrutiny from the IRS. In one meeting, Cypress discussed the tax treatment of the neighboring Seminole tribe's distributions, on which the Seminole tribe withheld taxes, and explained that the Seminoles' distributions were taxed because they were from net profits as opposed to the Tribe's distributions from its gross receipts tax.

In 2003, the Tribe obtained a legal opinion from its outside counsel stating that the distributions were taxable to tribal members. The Tribe opened a reserve account around the time that the IRS began auditing the Tribe and casino in 2005. The reserve account was meant to prepare for the possibility that the Tribe would have to make a settlement payment to the IRS.

James Clay and Audrey Osceola, a married couple, are tribal members who received quarterly distributions for 2004, 2005 and 2006, the years at issue. Clay and Osceola filed joint tax returns for those years which were prepared by their accountant. Clay and Osceola did not disclose the quarterly distributions to their accountant and did not report them on their tax returns. In 2010, the IRS audited dozens of returns filed by tribal members, including those of Clay and Osceola, and issued a notice of deficiency, in addition to penalties for negligence and substantial understatement of tax for the years at issue. Clay and Osceola challenged the notice in the Tax Court, arguing that the distributions were derived from a lease of Tribal land to the casino and therefore exempt from federal tax.

The Tax Court sustained the IRS's determination and held that the distributions were taxable to Clay and Osceola. The Tax Court found that the distributions were taxable under the Indian Gaming Regulatory Act (IGRA), which provides that per capita gaming payments to tribal members are subject to federal taxation, and found that no statutory exceptions applied. The Tax Court noted that, in U.S. v. Jim, 2018 PTC 161 (11th Cir. 2018), the Eleventh Circuit held that the distributions to another member of the Tribe were taxable, and the Tax Court saw no factual distinctions in this case. The court rejected Clay's and Osceola's argument that the distributions were derived from a lease because it found no evidence of a lease between the Tribe and the casino. The court explained that, although ambiguities in treaties and statutes are resolved in favor of Indians, this rule of statutory construction comes into play only when a statute can be reasonably construed to confer an income exemption, which the court concluded was not the case in this instance.

The Tax Court did not, however, uphold the penalty determinations because it found that the IRS failed to obtain written supervisory approval. The court noted that supervisory approval occurred after the initial determination of the proposed penalties had been communicated to Clay and Osceola, and was therefore not timely under Code Sec. 6751(b).

For a discussion of amounts excluded from income under Indian tribal government programs, see Parker Tax ¶79,720. For a discussion of the supervisory approval requirement for penalty assessments, see Parker Tax ¶262,195.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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