Federal Court Decisions Address Exemptions under the Federal Unemployment Tax Status Act and State Taxation of Income Earned Outside the State and Reservation

This General Memorandum reports on a Ninth Circuit decision on the application of the Federal Unemployment Tax Status Act to Indian tribes and an Eighth Circuit decision on the power of states to tax tribal income earned outside the taxing state and also outside of Indian Country.

Blue Lake Rancheria v. United States

On August 11, 2011, the United States Court of Appeals for the Ninth Circuit decided an important case on the application of the Federal Unemployment Tax Status Act (FUTA) to Indian tribes. In this case, the Blue Lake Rancheria sought a refund of taxes paid under FUTA on the employment of certain employees of a tribally owned for profit business, Mainstay Business Solutions (MBDS). Under the Internal Revenue Code, the definition of employment excludes “services performed in the employ of an Indian tribe, or any instrumentality” of a tribe. 26 U.S.C. § 3306(c)(7). The lower court held that the exemption applies only when the tribe is the “common law employer,” and not where it is only a “statutory employer” which is only responsible for paying the wages of the employees. According to the lower court, the Tribe failed to establish that it was the common law employer of the workers.

The Court of Appeals agreed that statutory employers are not exempt from FUTA but also held that the Blue Lake Rancheria was exempt because it was the “common law employer” of the relevant employees. It held that in determining whether an entity is a common law employer the court should apply the rules laid down by the Supreme Court in Community for Creative Non-Violence v. Reid, 490 U.S. 730 (1989) (whether the employer controls the manner and means by which the product is accomplished; the skill required; the source of the instrumentalities and tools; the duration of the relationship; whether additional projects can be assigned; and a number of other factors.) See also Treasury Regulation § 31.3306 (i)-1(b).

Fond du Lac Band of Lake Superior Chippewa v. Frans

In this case, the Fond du Lac Band sought to prevent state taxation of out-of-state pension income of members of the Band. After discussing the leading cases of McClanahan v. Ariz. State Tax Comm’n, 411 U.S. 164 (1973), which held that tribes could not be taxed on income earned on their reservations by a state (unless specifically authorized by Congress), and Mescalero Apache Tribe v. Jones, 411 U.S. 145 (1973), which held that tribes could be taxed by states on activities “occurring within the State but outside Indian country,” the Court of Appeals observed that the Fond du Lac facts fell between the two decisions. It concluded that the phrase “within the State” did not mean to limit the exemption to income earned within the taxing state. As a result, it held that the exemption did not apply to the income earned by members of the tribe in another state and outside Indian Country. A strong dissent argued that a reservation tribe is exempt even though the income is earned in another state, relying on Cohen’s Handbook of Federal Indian Law, p. 695 (2005), n. 207, and other authority.

We will follow both Blue Lake Rancheria v. United States and Fond du Lac Band of Lake Superior Chippewa v. Frans if they are appealed. Please let us know if we may provide additional information regarding either case.