IRS Issues Interim Guidance on Tax Treatment of Direct Pay Lease Funds
The Internal Revenue Service recently issued interim guidance on the tax treatment of per capita distributions to tribal members from certain direct pay leases (i.e., leases of trust lands where the lease payments are made directly to a Native American tribe rather than to a trust account held by the Secretary of the Interior). The interim guidance directs IRS employees to apply the standards set forth in IRS Notice 2015-67 when determining whether per capita distributions of direct pay lease funds are subject to information reporting or withholding taxes.
The Secretary of the Interior is required to accept certain types of payments for deposit into a tribal trust account. Permitted payments include money directly derived from the sale or use of trust lands when payment is made directly from the purchaser or lessee to the Secretary of the Interior.
IRS Notice 2015-67 addresses the tax treatment of per capita distributions made from funds held by the Secretary of the Interior in a tribal trust account. The notice provides that such distributions are generally excluded from the gross income of the tribal members receiving the distributions. The notice also provides, however, that distributions to tribal members from a trust account constitute gross income to the members if the tribal trust account is used to mischaracterize taxable income as per capita distributions. The Notice provides three examples of situations in which distributions from a tribal trust account will not be treated as nontaxable per capita distributions: 1) mischaracterized compensation; 2) mischaracterized distributions of business profits; and 3) mischaracterized gaming revenues.
The notice does not address the treatment of direct pay leases. The absence of guidance on direct pay leases caused many tribes to explore the administratively burdensome process of amending their leases to remit lease payments to a tribal trust account maintained by the Secretary of the Interior.
The interim guidance applies the guidance in Notice 2015-67 to direct pay leases, so amending leases is no longer necessary to obtain tax-free treatment of per capita distributions from lease payments that are otherwise within the scope of the notice. In the interim guidance, the IRS recognized that both tribes and the Department of the Interior often prefer direct pay leases because they enable faster payments and remove the need for Interior to manage the funds.
The IRS will incorporate the interim guidance into the Internal Revenue Manual within one year. However, Native American tribes and their members can rely on it immediately and should consult with counsel about whether to seek refunds of distributions previously reported as taxable.