The Internal Revenue Service's campaign against tribal governments faces "substantial" problems in the courts, the agency was warned in a newly disclosed internal memo.

On August 12, 2002, an IRS attorney said the agency has a "legitimate" case in going after a tribe who financed a golf course with tax-exempt bonds. A golf course -- or a hotel or casino, for that matter -- is a "commercial" project that doesn't qualify for tax-free financing, the attorney argued.

But Timothy Jones, who was acting assistant chief counsel at the IRS, warned of potential pitfalls if the case went to court. He said the tribe could point to the numerous golf courses operated by state and local governments. As of 1998, there were nearly 2,700 such courses throughout the nation, according to the memo.

Jones further argued the courts might rule against the IRS because the law and regulations governing the issue are somewhat ambiguous. In these cases, precedent traditionally would favor tribes, he said.

"Because of what we see as substantial litigating hazards, we caution that we would not recommend litigating the issue," Jones wrote in a memo sent to higher officials in the IRS.

Despite the advice presented in the field service memo, the IRS went ahead and targeted nearly a dozen tribes who financed projects with tax-exempt bonds. Charles Anderson, a field manager for tax-exempt bonds, has repeatedly said that casinos, hotels and similar developments don't meet the "essential" government function test in the law.

"If there are more golf holes than tribal members it is probably commercial and intended solely for tourists," he said for a November 3 story in The Bond Buyer, a specialty publication.

"We are not OK with tribes issuing tax-exempt bonds for commercial tourist facilities," he told The Los Angeles Times in an April 13 story.

The IRS campaign has forced the Seminole Tribe of Florida to restructure its $430 million bond package. The tribe used the money to build two highly successful casino resorts. The Cabazon Band of Mission Indians in California is near an agreement over $145 million in tax-exempt bonds used to expand its casino.

The tribes are redoing the deals to avoid tax penalties but have indicated they will fight the IRS in court. Some lawyers said the tribes have a good case, based on information in the previously confidential memo.

"Frankly, I don't see how the IRS can continue to challenge these financings now that this is out," said Thomas D. Vander Molsen, one of three attorneys quoted in the Bond Buyer story.

Molsen and his law firm, Dorsey & Whitney, which represents a number of tribes, including the one who financed the golf course described in the memo. The firm uncovered the document through a Freedom of Information Act request.

The IRS had previously released the field memo but the section that analyzed the legal issues was not made public. In the newly released version, two paragraphs are still blacked out.

Yet the memo warns that "it is probable that a court, faced with this fairly common activity of state and local governments, and taking into account the interpretative standard accorded tribal governments, would conclude that the Golf Course meets the statutory standard for an essential governmental function."

In hopes of clearing up the debate, Rep. J.D. Hayworth (R-Arizona) has repeatedly introduced bills to ensure tribal governments are treated the same as other governments for purposes of tax-exempt bonds. None of the bills has passed the Congress, however.

Rep. Tom Cole (R-Oklahoma), a member of the Chickasaw Nation, said last week at the National Congress of American Indians annual conference that he supports these proposals. "If you're going to treat tribes as governments, as sovereign entities, you need to treat them as other sovereign entities," he said.

Get the Memo:
INTERNAL REVENUE SERVICE NATIONAL OFFICE FIELD SERVICE ADVICE (August 12, 2002)

Relevant Links:
Tax Exempt Bond Community - http://www.irs.gov/taxexemptbond