September 24, 2009

Senate Indian Affairs Committee Holds Hearing on Tax Treatment of Health Care Benefits Provided by Indian Tribal Governments

Holland & Knight Alert
Philip Baker-Shenk

On September 18, 2009, the Senate Committee on Indian Affairs held an oversight hearing to examine an emerging – and to some, controversial – Internal Revenue Service (IRS) policy of treating health benefits provided by Indian tribes to their members as taxable income. (It was initially scheduled for September 17 but was rescheduled because Chairman Byron Dorgan (D-ND) had conflicting obligations.) Senator Tom Udall (D-NM) chaired the hearing and was the only senator in attendance.

Senator Udall’s Statement

In his opening statement, Senator Udall said it is well documented that the federal government is failing to meet its obligations to provide health care to Native American Indians; also, that Native Americans face health disparities at almost every level, and that American Indians and Alaska Natives face lower birth rates, shorter life spans and significantly higher rates of disease such as diabetes, suicide and substance abuse than the general population.

According to Senator Udall, the Indian Health Service (IHS) is attempting to address the sharp disparities in health outcomes but faces chronic funding shortages; in addition, the services offered often are outdated. He noted that Contract Health funding is often fully expended halfway through the year. When funds run out, he said, IHS is forced to ration services and limit treatment to those patients who face the immediate loss of life or limb. Because of the failure of the United States to meet these needs, he added, some Indian tribes are using their own tribal revenue to supplement the inadequate health services offered by the IHS, and other tribes are providing private health insurance coverage for their members to help offset the failures of the Indian health system.

These efforts are being met with resistance, Senator Udall added, as some tribal health programs are now under review by the IRS to determine whether they should be treated as taxable income. He commented that the IRS should be mindful of the federal government’s obligations to Indians when making decisions about taxability, and said that the federal government should not penalize Indian tribes for meeting obligations the government itself is failing to meet.

Witness Testimony

The following five witnesses appeared and provided testimony:

    • Sarah Hall Ingram, Commissioner, Tax Exempt and Government Entities Division, Internal Revenue Service. Ms. Ingram led off with testimony that described the rationale being used by the IRS to pursue the taxation of certain health benefits provided to tribal members by Indian tribes. She asserted that the “general welfare exclusion” doctrine has been applied to benefits provided by both tribal and non-tribal governments, and explained that to be excluded from taxable income, a health benefit must be provided pursuant to a consistently applied standard of financial need. Ms. Ingram also said that even if the general welfare doctrine did not apply, if a tribe had a comprehensive health plan for its members (whether through self-insurance or commercial insurance), only the value of the insurance coverage would be taxable to the members, not the benefits actually provided under the plan. Further, she said, if a tribe had an ad hoc approach of reimbursing members for health benefits, it could exclude the value of such benefits only if it met the general welfare doctrine.
    • The Honorable Jefferson Keel, Vice President, National Congress of American Indians. In his remarks, Mr. Keel said there has been little to no guidance on the taxability issue by the Treasury Department. Instead, he asserted, IRS auditors are creating policy through the rote application of the tax code. He called for a two-track effort to address the problems the IRS is causing. First, he said, Congress should enact legislation that would exempt health care services provided by Indian tribes; second, Congress should oversee the Treasury Department and IRS more closely to ensure that adequate policy guidance is being provided.
    • The Honorable Mark Macarro, Chairman, Pechanga Band of Luiseno Indians. Mr. Macarro explained how Pechanga decided to institute a universal health coverage program for its members. Until 2002, Pechanga tribal members relied primarily on an underfunded IHS for their health care, he said, but after a review of various options, the tribe’s legislature decided to purchase a group health policy that covers all tribal members. This switch led to measurable improvement in the physical health of the tribe, according to Chairman Macarro, who asserted that it makes no sense for the IRS to tax Indian tribes on health care benefits when tribes are stepping in where the United States has fallen short.
    • The Honorable Andrew Joseph, Jr., Board Member, National Indian Health Board. Mr. Joseph said that IHS is currently funded at 54 percent of identified need, and that until IHS is fully funded, many Indian tribes will find it necessary to supplement federal funding to provide needed health care services to their people. He noted that all 564 tribes prove health care services under some level of IHS contracting. Health care benefits received from the IHS are not taxable, he said, and tribal assistance should be treated the same way.
    • Scott A. Taylor, Professor, University of St. Thomas School of Law. Professor Taylor said the IRS should provide clarity and consistency to Indian tribes by issuing a revenue ruling stating that health care provided through insurance or reimbursement is excluded from gross income. He noted that the IRS issued a revenue ruling finding that Medicare benefits are not taxable. (This ruling does not take financial need into consideration.) Further, he said, the IRS has not tried to tax benefits provided by the Veterans Administration or the IHS. All of these benefits are provided because of status, and health benefits provided by Indian tribes are no different. Mr. Taylor also noted that in 2006 the IRS issued a private letter ruling stating that for the general welfare doctrine to apply, the “need” does not have to be financial.

Questions from the Senator

During the question and answer period, Senator Udall asked a number of questions about the IRS Indian Tribal Governments office (ITG), including what its role is within the IRS. Ms. Ingram responded that ITG was responsible for administering uniform tax laws appropriately in Indian Country. Senator Udall responded that ITG should be Indian Country’s voice on these issues. Further, he said, the IRS, as part of the federal government, has a responsibility to view its relationship with Indian tribes in the proper context; it is a government-to-government relationship in which the United States has failed to live up to its promises to provide health care.

Senator Udall also highlighted the point made by Mr. Taylor: the IRS currently treats the value of the health care benefits received through Medicare, the Veterans Administration and the IHS as excluded from the patient’s gross income. He pointedly asked Ms. Ingram to explain why the IRS is treating Indians differently. She responded that the IRS needs to be careful to treat all governments equally. In addition, she said, the Medicare ruling was grounded in reasoning from the 1940s and the general trend of providing a societal safety net. Lastly, Ms. Ingram noted that Medicare benefits are theoretically purchased with after-tax dollars because individuals must work and pay employment taxes to qualify. Senator Udall did not appear to be satisfied with this answer, so Ms. Ingram agreed to give the question more thought.

Senator Udall asked Mr. Taylor if he had any thoughts regarding Ms. Ingram’s response. Mr. Taylor answered by citing flexible spending accounts as an example of the federal government allowing individuals to purchase medical services with pre-tax dollars. He also noted that when he was employed by the federal government, he worked on a regulations project that lasted one week from start to finish, so he is unclear as to why the IRS cannot just issue a revenue ruling that exempts tribally provided health benefits.

Although the focus of the hearing was on the taxation of health benefits, Mr. Keel pointed out that some IRS agents are pursuing other tribally provided benefits, such as education, meals and housing. In his view, the problem of overly aggressive IRS enforcement goes beyond just health care.

Legislation Introduced

On September 21, 2009, California Congressman Xavier Becerra, along with 18 co-sponsors, introduced H.R. 3608, a bill that would codify the exclusion from gross income of medical care provided for Indians. North Dakota Senator Kent Conrad filed similar legislation as an amendment to the health care reform bill. On September 22, 2009, Senator Conrad’s amendment was accepted into Chairman Baucus’ modified mark up document.

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