Proposed Regulations Provide Clarity on Tax Treatment of Entities Wholly Owned by Tribal Governments

The U.S. Department of the Treasury and IRS issued Proposed Regulations on Oct. 9, 2024, providing long-awaited guidance on entities wholly owned by Tribal governments and organized or incorporated exclusively under the laws of the Tribes that own them. The Proposed Regulations confirm that those wholly owned entities are not recognized as separate entities for federal tax purposes (other than for purposes related to Internal Revenue Code Section 6417 elections) and, therefore, such entities are not subject to federal income tax. Except in limited circumstances, wholly owned, Tribally chartered entities may apply the Proposed Regulations retroactively. 

The Proposed Regulations were issued on the heels of the Treasury Department's proposed regulations on the Tribal General Welfare Exclusion Act. Together, these efforts form part of a series of Tribal tax guidance projects that moved forward under the leadership of Lynn Malerba, the first Native American Treasury Secretary, and Fatima Abbas, the first director of the Treasury Department's recently established Office of Tribal and Native Affairs. The Treasury Department and IRS also worked in consultation with the Treasury Tribal Advisory Committee on developing examples to include in the Proposed Regulations.

Background

The Proposed Regulations have been anticipated by Indian Country for more than 20 years. Although Tribes themselves are not subject to federal income tax, and the federal government has long recognized Tribal sovereign immunity, the status of Tribes' wholly owned entities has been less certain. Over time, there have been milestones leading up to the Proposed Regulations, including:

• On Dec. 18, 1996, the Treasury Department and IRS published final regulations under Section 7701, known as the entity classification regulations. These regulations provide that federally chartered Tribal corporations, i.e., those entities formed under Section 17 of the Indian Reorganization Act of 1934, as amended, 25 U.S.C. 5124 (Section 17 Corporations), or under Section 3 of the Oklahoma Indian Welfare Act, as amended, 25 U.S.C. 5203 (Section 3 Corporations) are not recognized as separate entities for federal tax purposes.
• Beginning in 2001, the Treasury Department and IRS included in their annual Priority Guidance Plan issuing guidance on the tax status of Tribally chartered corporations.
• The Treasury Department and IRS have held Tribal consultations on Tribally chartered corporations over the years, most recently on Oct. 8 and 10, 2019, and June 21 and 22, 2023.
• The Inflation Reduction Act of 2022 (IRA) added Section 6417 to the Internal Revenue Code, which allows applicable entities (including Tribal governments) to elect to receive a direct payment in lieu of a tax credit for 12 of the IRA's energy-related tax credits.
• In December 2023, President Joe Biden issued Executive Order 14112, "Reforming Federal Funding and Support for Tribal Nations to Better Embrace Our Trust Responsibilities and Promote the Next Era of Tribal Self-Determination." The Executive Order requires agency heads to take certain actions, consistent with applicable law and to the extent practicable, to increase access to "Federal funding and support programs for Tribal Nations" and provide Tribal nations the flexibility to improve economic growth and address the specific needs of their communities and reduce administrative burdens.

What Are Tribally Chartered Entities?

Tribally chartered entities are those that are organized or incorporated under Tribal law. The entity could be a limited liability company (LLC), corporation or other type of organization. A Tribe may determine it is in its best interest to form a Tribally chartered corporation over a corporation formed under state law for several reasons – for instance, forming a corporation under state law would typically mean that the entity would be denied sovereign immunity and likely be subject to taxation and various other state law requirements. Additionally, forming a Section 17 or Section 3 Corporation often does not meet a Tribe's needs due to the multistep formation process involved, federal oversight, increased costs and the difficulty dissolving such an entity. As a result, Tribal governments may prefer to form a Tribally chartered corporation.

For decades, however, the tax treatment of Tribally chartered corporations has been unclear. The IRS developed a six-factor test to determine whether an entity qualifies as an arm or instrumentality that shares the tax-exempt status of a Tribal government. However, this test is not sufficiently broad to capture the services Tribally chartered entities provide or their roles within Tribal governments. Further, the facts-and-circumstances test does not provide the certainty Tribes need in order to effectively utilize Tribally chartered corporations.

How Does the Election Under Section 6417 Impact Tribal Governments and Tribally Chartered Corporations?

Prior to the IRA, Tribal governments could not easily access energy tax credits because they do not have a federal income tax liability to offset with a credit. Under Section 6417, passed as part of the IRA, certain "applicable entities" – which include Tribes – can now elect to be treated as if they made a payment of tax equal to the amount of an "applicable credit." Section 6417 allows Tribes to ask the IRS for a cash refund in the amount of the tax credit to which they are entitled – i.e., they can ask the IRS for a direct payment.

Under existing regulations, Section 17 and Section 3 Corporations are treated as "disregarded entities" for Section 6417 purposes. The applicable-entity owner of a disregarded entity that directly holds applicable credit property must make a Section 6417 election for applicable credits determined with respect to such property. For example, though a federally chartered Tribal corporation may own the applicable credit property, the Tribe would be considered the owner and, therefore, responsible for making the Section 6417 election. As the preamble to the Proposed Regulations notes, this would be administratively burdensome for Tribes and particularly complex in instances where two or more Tribes own an entity making a Section 6417 election. Accordingly, as discussed below, the Proposed Regulations instead treat the Tribally chartered entity as the "applicable entity" for Section 6417 purposes.

What Are Key Features of the Proposed Regulations?

Confirms Federal Tax Status of Tribally Chartered Entities. The Proposed Regulations provide that, except for purposes of Section 6417 elections, federally chartered Tribal corporations and Tribally chartered entities are not recognized as separate entities from the Tribes that own them for federal tax purposes. The preamble further clarifies that these entities would not be subject to federal income tax – including on income earned in the conduct of commercial business off the Tribe's reservation. The Proposed Regulations confirm that the conclusion is the same when multiple Tribes together wholly own an entity organized or incorporated under their respective laws. Such a wholly owned entity would share the tax status the Tribes wholly owning it and, therefore, would not be subject to federal income tax. The Treasury Department and IRS seek comment from Tribes on how the guidance should apply for employment and excise tax purposes.

The operation of the Proposed Regulations can be illustrated by a simplified example involving Tribe B, which incorporates Corporation X under its laws and owns all the shares of Corporation X.

Under the Proposed Regulations, Corporation X is not recognized as an entity separate from Tribe B for Federal tax purposes and is not subject to Federal income tax. For purposes of making a Section 6417 election, Corporation X is treated as an instrumentality of Tribe B and is the "applicable entity."

Simplifies Section 6417 Elections. The Proposed Regulations provide that federally chartered Tribal corporations and Tribally chartered entities would be treated as instrumentalities of Indian Tribal governments. Thus, under the Proposed Regulations, each of these entities would satisfy the definition of an "applicable entity" under the IRA and, as such, may qualify for, register for and make the Section 6417 election for direct pay on 12 of the IRA's energy tax credits. This benefit would apply to Tribally chartered entities and federally chartered Tribal corporations that are wholly owned by multiple Tribes such that the federally chartered Tribal corporation or the Tribally chartered entity would register for and claim the applicable clean energy tax credit through the Section 6417 election.

Reduces Administrative Burdens on Tribes. In response to Tribal feedback, the Proposed Regulations do not impose an integral part test or introduce new reporting requirements. Together, the absence of these features will improve clarity and reduce compliance burdens on Tribes.

Request for Public Comments

In a Dear Tribal Leader Letter, the Treasury Department and IRS requested comments on the following topics:

1. The Notice of Proposed Rulemaking (NPRM) provides Tribally chartered entities parity with federally chartered Tribal corporations. What questions or comments do you have regarding this proposed rule?

2. The NPRM recognizes that Tribally chartered entities are not recognized as separate from their owning Tribe(s) for federal tax purposes.

a. How should this impact employment and excise tax? Should Tribally chartered entities remain separate for excise and employment tax liability?

b. Should Tribally chartered entities be able to assert the excise tax benefits of their owning Tribes?

3. The NPRM contains examples describing how the proposed rule would operate. Do you have comments about these examples? Should the Treasury Department include more examples, and if so, what topics should be addressed?

4. The NPRM explains that Tribes may rely on these rules for tax years that precede the date of the NPRM except for limited circumstances. What questions or comments do you have regarding this reliance proposal?

5. The NPRM explains that these proposed rules do not address Tribally chartered corporations that are partially owned by persons other than Tribes and that additional guidance on this topic will be subject to Tribal consultation. What questions or comments do you have about this statement in the NPRM?

6. The NPRM explains that Tribally chartered entities would be eligible for certain clean energy tax credits through elective pay. For the limited purpose of reducing administrative burdens, the NPRM would allow certain Tribal entities to be treated as an instrumentality of an Indian Tribal government. What questions or comments do you have regarding this proposed rule? What other questions or comments do Tribes have regarding this NPRM?

Next Steps

The Treasury Department has offered several opportunities for Tribes to comment and provide feedback on the Proposed Regulations:

• Participate in Tribal consultations, which were held virtually Dec. 16-18, 2024.
• Attend the public hearing on Jan. 17, 2025, at Internal Revenue Building, 1111 Constitution Avenue, NW., Washington, D.C., or join the hearing by phone. All persons who wish to attend (whether in person or by phone) must register to do so by Jan. 15, 2025.
• Submit written comments on the Proposed Regulations by Jan. 21, 2025, and offer suggestions for how they can be refined.

Holland & Knight Insights

The Proposed Regulations are a welcome development that provides much-needed clarity to Tribal governments on the tax treatment of wholly owned, Tribally chartered entities. However, Tribal governments should continue to press the Treasury Department and IRS for more guidance in this area. Specifically, the tax treatment of a corporation partially owned by a Tribal government remains unclear. Guidance is needed because Tribes are increasingly forming entities with non-Tribal partners for energy-related projects and other ventures.

For more information or questions, please contact the authors.

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