Tax scams come in many shapes and sizes. Some schemes aim to steal money or identities, while others present as legitimate-looking investment opportunities with promises of reducing tax bills. These offers often come from law firms, investment groups, financial advisors, and even sophisticated organizations. They tempt taxpayers with strategies like inflated art donation deductions, film investments, and even Native American Tax Credits.
The IRS advises taxpayers to consult independent tax or legal professionals to avoid falling prey to aggressive promoters. But as tax planners, how do we determine if a strategy is legitimate? Who do we consult so we can understand the difference between a scam and a scheme? Think Outside the Tax Box of course!
One popular scheme being whispered about in tax conferences this year is the so-called “Tribal Tax Credits.” It’s been a hot topic, with many professionals asking about its legitimacy. Let’s dive into the details to better understand this intriguing yet questionable opportunity.
Breaking Down the Investment Pitch
The specific opportunity we’ll discuss today involves purchasing “Sovereign Tribal Tax Credits.” Here’s how it’s marketed:
- Partnership Creation: A Native American tribal organization partners with a private company to create tax credits intended to fund tribal economic development, such as infrastructure projects or supporting local businesses.
- Discounted Credits: Investors can buy these tax credits at a discount—for instance, paying $60,000 for a credit worth $100,000.
- Tax Filing Benefit: Investors apply the full $100,000 credit to reduce their federal income tax liability, potentially saving $40,000. The difference between what they paid and the credit’s value represents their financial gain.
- Government Backing: The program claims to align with U.S. Treasury policies supporting tribal sovereignty and economic growth. However, the IRS hasn’t explicitly defined these credits, leaving uncertainty about their legitimacy.
At first glance, this seems like a win-win: reduced taxes for the investor and funding for tribal programs. But is it legal? Let’s examine the framework.
Legal Foundations: Fact or Fiction?
The legitimacy of this strategy depends on whether it’s authorized under existing tax laws. Here’s what we know:
- Tribal Self-Governance Act of 1994 (HR 3508): This law allows tribes to manage their resources and programs under agreements with the U.S. government, promoting self-determination. It doesn’t specifically authorize the sale of tax credits but may be used as a foundation for tribal economic activities.
- New Markets Tax Credit (NMTC) Program (IRC Section 45D): This program incentivizes investments in low-income communities (including tribal areas) through tax credits. However, NMTCs must be allocated by a certified Community Development Entity (CDE) and can’t be sold directly by a tribe. (they must be sold by the CDE)
- Native American Tribal Trust Fund: Some offers reference tax credits tied to a “Native American Tribal Trust Fund,” which is claimed to be administered by the U.S. Treasury. However, this claim lacks direct reference to specific statutory authority for selling such credits.
- General IRS Rules on Transferable Tax Credits: Transferable tax credits, like those used in renewable energy or film production, are explicitly authorized by the Internal Revenue Code. In this case, there is no clear statutory provision cited in the documents that grants tribes similar authority to create and sell transferable or refundable tax credits.
- Inflation Reduction Act Tax Credit Monetization: The Inflation Reduction Act’s new direct pay and transfer options allow more organizations to utilize clean energy tax credits for equipment placed in service on or after January 1, 2023 and through December 31, 2032. The direct pay option allows certain non-taxable entities to directly monetize certain tax credits for entities such as tribal governments, and others to directly monetize specific tax credits including many renewable energy credits such as the ITC and the PTC. Applicable entities may elect to treat these tax credits as refundable payments of tax. Such entities are eligible to receive a direct payment from the IRS for any amount paid in excess of their tax liability for credits. The Inflation Reduction Act also allows eligible taxpayers that are not tax-exempt entities to transfer all or a portion of certain tax credits, including the ITC and PTC, to an unrelated party. However, the Act’s references to credits mentions only renewable energy related tax credits and does not reference other credits such as Sovereign Tribal Tax Credits.
Key Risks and Gaps
The programs we’ve reviewed appear to rely on interpretations of laws supporting tribal sovereignty and economic development. However, without explicit statutory or IRS guidance, there’s significant legal uncertainty. The absence of a clear framework leaves room for IRS challenges or disallowance during audits.
Naturally, the brokers promoting these investments encourage potential buyers to “check with their tax advisor.” While prudent advice, it places the burden on the investor to ensure compliance.
Over the years of reviewing tax reduction arrangements, some promoters will supply a law firm opinion memo. While this can be encouraging, be sure to determine the firm is protected by proper insurance in case future exams go south.
Next Steps for Evaluating Legitimacy
If you’re considering this or a similar opportunity, take these steps to protect yourself:
- Request Documentation: Ask for specific statutory or regulatory authority supporting the program’s claim that tribes can sell these tax credits.
- Seek Independent Opinions: Consult a tax attorney or advisor specializing in tribal tax law to assess the program’s legality and IRS compliance.
Request an IRS Private Letter Ruling: Obtain a ruling to confirm whether the credits are recognized and can be used to reduce federal tax liability.
Final Thoughts
While investing in tribal initiatives is a noble cause, the legal standing of “Sovereign Tribal Tax Credits” remains murky. The legality of any tax reduction strategy, of course, relies on the details of each specific offer. The example discussed in today’s article highlights just one such arrangement currently on the market, and its validity cannot be assumed without thorough scrutiny. As tax planners, it’s our responsibility to scrutinize these opportunities to protect our clients—and ourselves—from potential pitfalls. Remember: if something seems too good to be true, it probably is.
