Cross v. Commissioner

OPINION

Wilbur, Judge:

In these consolidated cases, respondent determined the following deficiencies and additions to tax in petitioners’ Federal income taxes:

Sec. 6653(a)1 Docket No. Petitioner Year Deficiency addition to tax

11879-78 Silas V. and 1976 $27,233 $1,362 Millie Cross

11880-78 Silas A. and 1976 542 27 Francine V. Cross

After concessions, the only issue remaining for our decision is whether income earned by an enrolled member of the Puyallup Indian Nation from the operation of a smokeshop upon land held in trust by the United States is subject to Federal income taxation.2

This case was submitted under Rule 122, Tax Court Rules of Practice and Procedure. All facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.

The petitioners in each of these cases are husband and wife. Petitioner Silas V. Cross and petitioner Silas A. Cross are father and son and both are enrolled members of the Puyallup Indian Nation. All petitioners resided in Tacoma, Pierce County, WA, within the boundaries of the Puyallup Indian Reservation when the petitions herein were filed.

Petitioner Silas V. Cross (Cross) is the beneficial owner of land held in trust by the United States of America (trust land).3 The original patent granting beneficial ownership of the trust land was issued to his grandfather on January 30, 1886, under the provisions of the Medicine Creek Treaty of 1854 (Medicine Creek Treaty), 10 Stat. 1132.

The trust land also falls under the jurisdiction of the General Allotment Act of 1887, 24 Stat. 388, 25 U.S.C. sec. 331 et seq. (1982). The purpose of the General Allotment Act is to preserve the value of land in trust until the Secretary of the Interior determines that the individual allottee is competent to hold title to the land in fee simple.4

Cross operates the Cross Smokeshop on 0.62 acres of the original patent allotted to his grandfather in 1886. In 1976, the fair rental value of the 0.62 acres was $6,500, based upon the rental value of the property for use in the operation of a smokeshop or other similar commercial enterprise, the highest and best use of this particular property.

In 1976, the net profit received by Cross from operation of the smokeshop was $41,687. This income resulted from the sale of cigarettes, other tobacco products, and merchandise sold in the smokeshop. The son (petitioner Silas A. Cross) received $1,899 in wages for working at the smokeshop in 1976. None of the petitioners reported these amounts as income on their respective joint 1976 Federal income tax returns.

Respondent determined that both the smokeshop income and the wages paid to the son were includable in petitioners’ respective gross incomes.

Section 61 defines gross income to include "all income from whatever source derived.” It is well established that the income of Indians is taxable under this section, "unless an exemption from taxation can be found in the language of a Treaty or Act of Congress.” Commissioner v. Walker, 326 F.2d 261, 263 (9th Cir. 1964); Jourdain v. Commissioner, 71 T.C. 980 (1979), affd. 617 F.2d 507 (8th Cir. 1980); Hoptowit v. Commissioner, 78 T.C. 137 (1982), affd. 709 F.2d 564 (9th Cir. 1983). The mere fact that petitioners are Indians will not preclude them from being liable for the payment of income tax. Choteau v. Burnet, 283 U.S. 691 (1931); Superintendent v. Commissioner, 295 U.S. 418 (1935). In order to prevail, petitioners must point to "express exemptive language in some statute or treaty” showing that they need not include amounts in their gross income. United States v. Anderson, 625 F.2d 910, 913 (9th Cir. 1980); Karmun v. Commissioner, 82 T.C. 201, 204 (1984).5 See Welch v. Helvering, 290 U.S. 111 (1933).

Petitioners have failed to show an express exemption in any treaty or act of Congress. Thus we must agree with respondent that income from the smokeshop, as well as wages paid for working in the smokeshop, constitutes taxable income under section 61.

Petitioners’ primary contention is that the Medicine Creek Treaty is a contract between the United States and the Puyallup Indian Nation reserving by implication the power of taxation in the Puyallup Indian Nation. Petitioners rely on two principles of contract construction: language is to be construed most strongly against the entity responsible for it; and, where items are specified in detail in a contract, other items of the same general character are excluded by implication on the ground that the specific terms express the meaning of the parties. C. Sands, Sutherland Statutory Construction (4th ed. 1972). We do not find these general principles of contract law to be applicable to this case.

The Medicine Creek Treaty, 10 Stat. 1132, in pertinent part states: "Article 12. The said tribes and bands finally agree not to trade at Vancouver’s Island or elsewhere out of the dominions of the United States.” Petitioners ask us to conclude that this geographical restriction in article 12 is the only trade limitation which was intended by the United States and the Puyallup Indian Nation when the treaty was executed. They argue that taxing the income from the smokeshop would be a further constraint on trade, not allowed under the treaty. We reject this interpretation as not arising from the plain language of article 12.

At the time the Medicine Creek Treaty was entered into, the Federal income tax did not yet exist. D. Posin, Federal Income Taxation, sec. 1.01, at 1 (1983).6 The parties surely did not intend a geographical trade limitation to restrict the taxing authority of the United States to impose a tax not in existence.

Moreover, we cannot find that petitioners have been exempted from the tax by implication. Mescalero Apache Tribe v. Jones, 411 U.S. 145, 156 (1973); Fry v. United States, 557 F.2d 646, 649 (9th Cir. 1977); Jourdain v. Commissioner, 71 T.C. at 990. Any exemption from taxation for Indians must be expressly stated in a treaty or act of Congress. United States v. Anderson, supra. The Medicine Creek Treaty simply does not provide petitioners with an express restriction on the ability of the United States to tax the profits arising from trade carried out on trust land. Earl v. Commissioner, 78 T.C. 1014 (1982).

The General Allotment Act, 25 U.S.C. sec. 331 et seq., under which jurisdiction the trust land falls, similarly fails to exempt petitioners’ income from taxation.7 In Squire v. Capoeman, 351 U.S. 1, 9 (1956), the Supreme Court concluded that there exists within the General Allotment Act, an exemption from taxation of income from land held in trust by the United States, if such income is "directly derived” from the land. Quite clearly, income from land is not generally exempt, but only income "directly derived” from the land. The profits from petitioners’ smokeshop do not fall within this narrow exemption.

In Squire v. Capoeman, supra, a noncompetent Indian contested the inclusion in gross income of amounts derived from the sale of timber growing on land held in trust for him by the United States pursuant to the General Allotment Act. "The land was forest land, covered by coniferous trees from one hundred years to several hundred years old,” and "was of little value after the timber was cut.” Squire v. Capoeman, supra at 4. Quoting an earlier attorney general, that "it is not lightly to be assumed that Congress intended to tax the ward for the benefit of the guardian” (351 U.S. at 8), the Court read the General Allotment Act as exempting from tax income "directly derived” from the land itself, thus exempting the timber sales proceeds from the capital gains tax. However, this exemption was restricted to income "directly derived” from the land itself. The Court stated that:

Once logged off, the land is of little value. The land no longer serves the purpose for which it was by treaty set aside * * * and for which it was allotted to him. * * * Unless the proceeds of the timber sale are preserved for [the taxpayer], he cannot go forward when declared competent with the necessary chance of economic survival in competition with others. * * * [Squire v. Capoeman, supra at 10. Fn. ref. omitted.]

In petitioners’ case, the continued use of the land for retail sales from a smokeshop does not decrease the economic value of the land nor impair the capacity of a competent Indian to "go forward * * * with the necessary chance of economic survival.” 351 U.S. at 10. In the circumstances before us, the land (along with other capital assets and labor) has been used to produce business income from the smokeshop. Unlike these circumstances, the cases which have applied the "directly derived” exemption involve only situations where there is exploitation of the land itself. Stevens v. Commissioner, 452 F.2d 741 (9th Cir. 1971) (income from farming and ranching is tax exempt); United States v. Daney, 370 F.2d 791 (10th Cir. 1966) (income from oil and gas leases is tax exempt); Hayes Big Eagle v. United States, 156 Ct. Cl. 665, 300 F.2d 765 (1962) (royalties from mineral deposits are tax exempt).

Having found no court which has exempted the income from retail sales from taxation under the authority of the General Allotment Act, we find no reason to do so either. Moreover, this Court has consistently held that income from the sale of cigarettes and tobacco (smokeshop income) is taxable. Hoptowit v. Commissioner, 78 T.C. 137 (1982).8 Our finding of taxability may reduce the profits retained by petitioners, but it does not interfere with either the trade rights granted under the Medicine Creek Treaty, or the intended purpose of the General Allotment Act.9

Petitioners’ alternative argument attempts an end run around this formidable line of authority. Petitioners argue that the portion of the smokeshop income allocable to the fair rental value of the unimproved land upon which the smoke-shop sits should be excluded as income "directly derived” from the land within the meaning of Squire v. Capoeman, supra. Put differently, petitioners argue that the fair rental value for the land of $6,500 is the amount of smokeshop income which is generated from the land itself and is properly excludable. For this indirect construction of income "directly” derived — a construction dramatically extending existing case law — petitioners rely only on dicta from Critzer v. United States, 220 Ct. Cl. 43, 597 F.2d 708 (1979).10

In effect, petitioners ask us to exclude imputed rent on the land from their smokeshop income on the theory that this imputed rental income is "directly derived” from the land within the meaning of Squire v. Capoeman, supra. Aside from the difficult computational and valuation problems involved, we are not willing to assume that this constructed value represents income "directly derived” from the land. Certainly it is a long, long way from the sale of timber in Squire v. Capoeman, supra, which the Supreme Court viewed as tantamount to a disposition of the land.11 Clearly, none of the cases have gone anywhere near as far as petitioners suggest. See Stevens v. Commissioner, supra (income from farming and ranching is tax exempt); United States v. Daney, supra (income from oil and gas leases is tax exempt); Hayes Big Eagle v. United States, supra (royalties from mineral deposits are tax exempt).

We speciñcálly decline to express any opinion on the results reached on different facts in Hale v. United States, 579 F. Supp. 646, 648 (E.D. Wash. 1984). Nevertheless, we agree with the court that:

The essential basis of Capoeman is the protection of the property right of the allottee during the trust period. See United States v. Anderson, 625 F.2d 910 (9th Cir. 1980) and Holt v. Commissioner, 364 F.2d 38 (8th Cir. 1966), cert. denied 386 U.S. 931 (1967). There is no exploitation of the land itself in this case, nor is its value reduced by the operation of the smokeshop. The plaintiffs argument ignores the word "directly” in the "directly derived” test.

We agree with the Hale court that the proper focus is on income directly derived from the land, and that to meet this test there must be some exploitation of the land itself. Indeed, if petitioners’ imputed rent exclusion is sanctioned, the word "direct” has little meaning, for all income connected in any way with the land would then be "directly derived” from the land. In Critzer v. United States, 220 Ct. Cl. at 52, 597 F.2d at 713, the court observed that if "plaintiff were to sit in a telephone booth on her Indian land and séll stocks and bonds by phone from the booth, it would be ludicrous to attempt to argue that any income, so earned, was directly derived from the land.” Yet petitioners’ imputed rent theory, if sanctioned, would require such a conclusion, and the conclusion would be applicable to a potentially endless variety of businesses. Declining to take through taxation a significant portion of a gain that effects a corresponding diminution of the trust asset is one thing; declining to tax income from repetitive use of the asset effecting no diminution in value is quite another. The former is a breach of faith with Indian citizens; the latter a breach of faith with all other taxpayers, including Indians. For these reasons, we note our agreement with Hale v. United States, supra, without further belaboring the additional problems petitioners’ theory presents.

Decisions will be entered under Rule 155.

Reviewed by the Court.

Dawson, Simpson, Goffe, Wiles, Nims, Shields, Swift, and Jacobs, JJ., agree with the majority opinion. Hamblen, J., dissents. Clapp and Gerber, JJ., did not participate in the consideration of this case.

All section references are to the Internal Revenue Code of 1954 as amended and in effect during the taxable year in issue.

Respondent conceded that petitioners were not liable for the addition to tax under sec. 6653(a) for the year 1976.

Petitioner has restricted title to this property, meaning that he is "noncompetent” to alienate or encumber the property without permission of the Secretary of the Interior. Generally, petitioner is classified as a noncompetent ward of the United States. See Stevens v. Commissioner, 452 F.2d 741, 742 n. 1 (9th Cir. 1971), affg. in part and revg. in part 52 T.C. 330 (1969), Supplemental Opinion 54 T.C. 351 (1970).

The purpose of the General Allotment Act is to protect Indians’ interest in their land and "to prepare the Indians to take their place as independent, qualified members of the modern body politic.” Board of Commissioners v. Seber, 318 U.S. 705, 715 (1943). The allotted parcels are held in trust until a time when the property is transferred to the allottee, "in fee, discharged of said trust and free of all charge or encumbrance whatsoever.” General Allotment Act of 1887, 24 Stat. 388, 25 U.S.C. sec. 348 (1982). Thus, the General Allotment Act seeks to preserve the value of the allotted land until the allottee is judged competent to handle his own affairs.

Cf. Swiger v. Commissioner, T.C. Memo. 1984-228 (where the Court restated the requirement of the presence of express language to exempt smokeshop income from taxation).

Cross v. Commissioner

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