A Tribal Executive’s Guide: Deferred Per Capita Plans

This article addresses a topic that has received increased attention from tribal members, financial service providers and tribal executives: How to offer tribal members the opportunity to elect on a year by year basis to place a portion of their per capita payments into a tax-deferred long-term saving vehicle. The tax benefits of these elective deferred income plans have been widely touted. This article calls attention to those benefits but also explores key structural issues for minimizing the risks of deferred income plans.

A-1. A deferred per capita plan is a plan sponsored by a Tribal government that permits its members to voluntarily invest a portion of their per capita distributions in a tax-deferred savings vehicle. It is very similar to a 401(k) plan sponsored by employers for their employees, but is easier to administer. However, since per capita payments are not "earned income," they cannot be contributed to an IRA or 401(k) plan

A-2. In addition to the tax savings discussed below, deferred per capita plans permit Tribal members to have a long-term savings mechanism that grows in value on a tax-deferred basis. For some Tribes, per capita distributions from gaming are very high right now, but this boom is not guaranteed to last. By saving a portion of their distributions, members can plan for the future and not have to depend exclusively on future Tribal distributions. This way, if the current per capita distributions decrease, members will still have financial resources. This can be especially important for members who are in or nearing their retirement years.

A-3. The federal tax savings deferred per capita plans create are two-fold: (1) reduced taxation on current per capita distributions and (2) tax-free growth of contributions to the plan. Amounts a participant contributes to the deferred per capita plan are not subject to taxation in the year during which the contribution is made. Instead, they are taxed when they are withdrawn or otherwise made available. Also, the contributions grow tax-deferred because investment gains are taxed when they are withdrawn or available for withdrawal.

Assume that in 2003, Rosa, an unmarried Tribal member living on the reservation, receives $100,000 in per capita distributions from gaming revenues as her sole source of income. If Rosa does not defer any income to a deferred per capita plan and takes the standard deduction, her taxable income will be $92,250 and her tax will equal $21,903.

If Rosa decides to defer 25% (or $25,000) of her per capita distribution into a deferred per capita plan, her taxable income will be $67,250. Under this scenario, Rosa will owe only $14,450 in federal income taxes, resulting in a net tax savings of $7,453.

In addition to saving $7,453 in federal income tax, by contributing to the plan, Rosa has saved $25,000 for a rainy day that will grow tax deferred.

If, beginning in 2004, Rosa saves $25,000 per year ($2,083/ month) for the next 15 years and averages approximately 9% annual growth in a diversified, balanced investment (65% stocks/35% bonds), she would have approximately $886,000.00 before taxes in 2019.

As pointed out in a recent article in Indian Gaming magazine, deferred per capita plans also offer significant collateral tax savings.¹ By reducing taxable income, a Tribal member may become eligible for tax credits and deductions that he other-wise would be unable to claim or use. Also, for Tribal members who are subject to state taxation, reducing federal tax-able income generally reduces state taxable income, and thus reduces state tax liability.

A-4. Yes, the IRS has approved a deferred per capita plan. In Private Letter Ruling 199908006 (the "PLR"), the IRS approved a plan that allows Tribal members to defer a portion of their per capita distributions. Before the PLR was issued, the IRS regularly permitted deferrals of earned income; however, we are aware of no other ruling that had addressed the deferral of unearned income.

The IRS has not approved any deferred per capita plans since the PLR and has temporarily taken a "no ruling" stance. The "no ruling" stance was adopted in connection with the solicitation of comments on similar deferred income arising in connection with a Tribe’s administration of minors’ trusts set up to hold gaming revenues for minors. There is no indication that IRS is inclined to issue guidance that would effectively revoke the PLR. However, to minimize risk, tribal deferred capita plans should be structured as much as possible like the plan described in the PLR.

A-5. The plans approved by the IRS in the PLR included two specific deferred per capita plans established by a Tribe. Both plans were completely elective. Under both plans, a member could elect to defer all or any part of his or her per capita distribution; the IRS did not limit the amount that may be deferred.

Assets contributed to the plan are placed in a grantor trust. Although placed in a trust, the assets must be subject to the claims of the Tribe’s general creditors.

Before the beginning of each year, each Tribal member who wants to participate in the plan submits an election form. The member uses the election form to designate the portion of his or her per capita distributions that should be contributed directly to the trust. This election must be completed and submitted before the funds used for the per capita distribution are earned by the Tribe. These annual elections are irrevocable once made, but advance distributions may be made for unforeseen emergencies at the discretion of the plan administrator.

Distributions under the two plans may occur in accordance with a variety of schedules. Participants could defer:

• Under Plan A, to age 65 (or until their death or disability, if sooner).
• Under Plan B, to a term certain:
• 10 years
• 15 years
• Under both plans, distributions could be paid out in a lump-sum payment or in installments.

• Irrevocable annual elections to defer
• Unlimited deferrals
• Deferred amounts placed in a trust (optional)
• Funds subject to claims of Tribe’s general creditors
• Enforceable contract right against Tribe
• Distributions available at certain age, upon death or disability, or after a term certain
• Distributions to be made in lump sum or installment payments

A-6. No, the assets do not need to be kept in a trust. The purpose of the trust is to provide some extra security to the contributing members. As discussed below, the Tribe is the owner of the assets and, if placed in a trust, the assets are segregated from the Tribe’s other funds. If segregated, the assets are not as accessible to the Tribe. This separation may be of more importance when a new Tribal council is elected or if Tribal revenues decrease significantly. But, regardless of whether the assets are kept in a trust, they must be subject to the claims of the Tribe’s general creditors.

A-7. The Tribe owns the funds contributed to the plan. Unlike the employees who contribute to a 401(k) plan, the individual Tribal member who makes contributions to a deferred per capita plan does not have an ownership interest in those funds. Instead, he or she has only an enforceable contractual right against Tribe for payment.

If the Tribal member were to have an ownership interest in the amounts, the member would need to include them in his or her taxable income because the IRS’s constructive receipt rules would be triggered.

A-8. Yes, although the Tribe has the responsibility of investing the assets, the Tribe can permit contributing members to provide advice regarding investment allocations. Additionally, the Tribe may (and should) use investment advisors and other professionals as needed.

A-9. Yes, the Tribe may invest amounts contributed to a deferred per capita plan in its own enterprises. As discussed above, the Tribe owns the assets and can use them any way it would like, as long as the Tribe maintains its end of the contractual agreement with the members who make the deferrals.

However, two issues must be appropriately dealt with where the Tribe does not invest the members’ deferrals in outside investments, such as mutual funds or other similar financial investments:

1. the resulting lack of diversification (the Enron problem); and
2. avoiding even the appearance of giving Tribal members an individualized equity interest in tribal profits.

A-10. Yes, constructive receipt and the IRS’s current "no ruling" stance are two risks associated with deferred per capita plans. If a plan is not structured properly, it could trigger "constructive receipt." Under the constructive receipt doctrine, income is taxable to a person when it is first made available. Additionally, amounts may become taxable if the individual receives the "economic benefit" of the funds. There-fore, if the deferred per capita plan is improperly structured, contributions to the trust would not be on a tax-deferred basis and income would not grow tax-deferred.

The IRS’ current "no ruling" position also counsels a conservative approach to the arrangement. Coupling the arrangement with other tax-favored investments, such as life insurance, or borrowing to increase deferrals, may increase the risk of IRS scrutiny.