It’s the sort of letter that no taxpayer wants to get, starting with the words, “We are examining your California Income Tax return.”
The recipients? California Indians who may wrongly believe their payments from casinos or other businesses are exempt from state income taxes.
But the implications of these rules may be far bigger than the state Franchise Tax Board (FTB) pulling in an extra few million dollars in revenue.
Indians can avoid paying taxes on some income, but that exemption doesn’t apply to money generated by Internet poker or other endeavors involving off-reservation computer servers — unless those businesses also satisfy those rules.
The FTB sends out between 500 and 600 of these letters a year, according to spokesman Dan Tahara. He added that the letters don’t represent a new crackdown, nor are they the result of a court case the FTB won earlier this year against a southern California gaming tribe.
In fact, he said, its business as usual.
“This is actually nothing new,” Tahara said. “This is part of an ongoing effort.”
Tribal income is exempt from taxation — but only under very specific and often misunderstood circumstances. These rules, meanwhile, could have implications for how new gaming enterprises are structured in the future, especially if tribes are able to gain a large stake in online poker franchises in California.
The FTB also puts out a booklet, “Taxable Income of Native Americans,” that details what kinds of income are exempt from state taxes. Another brochure available on the agency’s website notes that “many people are under the impression that California Indians do not pay income tax.”
In order to exempt payments from state income taxes, the money has to come from a “tribal enterprise” conducted by a federally recognized tribe. It has to be generated on a reservation, and the tribal member has to be a member of that tribe living on the same reservation where it was generated.
When tribal members file their taxes and indicate that they have income that is exempt from state income taxes, the FTB requires proof before they will finalize the return. When those forms aren’t filed with a return, a letter is sent automatically.
According to one Oct. 22 letter, the taxpayer must provide copies of documents such as tribal identification cards, utility bills and additional tax forms, all due within one month, in order to demonstrate exempt income.
As millions of dollars in revenues from tribal casinos have poured into formerly impoverished Indian communities, and with the state in its fourth year of a deep budget hole, the issue of what income is and is not taxable has become a more important one.
A year ago, the 29 Palms Band of Mission Indians sued the state, claiming that under federal law, members living off the reservation did not have to pay taxes on income generated on the reservation. The tribe operates the Spotlight 29 Casino, with 2,000 gaming machines.
The tribe claimed the requirement of living on the reservation was onerous and that there wasn’t sufficient tribal land to house all of the members. The tribe’s reservation consists of two plots with 400 total acres, the larger of which is nearly covered with the casino, its parking lot and other infrastructure. The other plot is mostly off the grid, with few connections to electricity or water utilities.
The tribe has only about a dozen adult members. About a third of them live outside California, and under state law, are exempt from taxes if they are not legal residents of California. Tribal members who are in the military are also exempt.
The case centered around a tribal member named Angelina Mike, and the $385,000 in casino payments she received in 2000. She was living on the reservation of the Agua Caliente Band of Cahuilla Indians, 18 miles away, but argued that she didn’t have to pay taxes because she was living on an Indian reservation.
The tribe lost that case, and a federal judge threw out an appeal in March. Mike, they ruled, broke the rules because she wasn’t living on her own tribe’s reservation, where the income was generated. Other taxpayers may run afoul of the FTB if they’re not reporting income from tribal businesses generated off of the reservation.
The case was much discussed on tribal blogs and news sites, with some people identifying enemies they say have been defrauding the FTB, offering up the agencies phone number, or asking if the agency pays reward money.
“It’s just a routine letter,” Tahara said. “We’re not increasing the effort based on the court case. It’s just business as usual.”
But “business as usual” could mean some big bills for back taxes. Tribal casinos in California bring in about $7 billion in gross revenues annually. Much of this goes to expenses like labor, bond payments and management contracts.
According to a 2006 report by then-Attorney General Bill Lockyer’s office, there were only about 3,500 Indians receiving casino checks that year — a tiny fraction of the 265,000 Indians and Alaska natives living in the state. Between limiting gaming expansion since that time and waves of disenrollments of tribal members, the number appears to have remained fairly steady.
Most of those people are getting monthly checks for at least $20,000 a month. If one assumes 3,500 people making an average of a quarter million a year, that’s $875 million in untaxed revenue.
If one assumes that the average tribal member getting casino checks gets $250,00 annually, and that most of this money would be taxed at 9.55 percent, the state’s second highest marginal income tax rate, a bill for not meeting the requirements would demand a repayment of over $20,000. If 100 letters resulted in further tax payments, that would equal $2 million a year. And some taxpayers will owe several years of back taxes.
“That’s significant money,” said Cheryl Schmidt with the gaming watchdog group Stand Up for California. “Figures show that only 16 percent of the population pays the majority of the taxes. If we could add another 3,500 people to that it would make a difference. It doesn’t’ balance the budget, but it helps.”
NEXT: A look at how tribes could pursue Internet gaming that would be tax-free for their members