Originally Published on forbes.com on August 19th, 2011
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Refund cases into seven figures will always catch my eye. For it to be a refund of federal unemployment taxes there have to be a lot of people involved. Mainstay Business Solutions had around 39,000 employees in 2003 and 2004. It’s not a group of employees or even Mainstay that is the plaintiff, though. Mainstay’s owner, Blue Lake Rancheria, sued for refund. Blue Lake Rancheria is a federally recognized Indian tribe with 53 members. I think the story deserves a little background. If you are familiar with the concept of tribal sovereign immunity I apologize for the next few paragraphs. It is an unfamiliar concept to many of us. I’m sure my brief explanation will be inadequate, but I’m hopeful that I’ll get some comments from those more knowledgeable on the topic.
One Nation – Many Sovereigns
I did a piece this week on the 11th Circuit’s decision in State of Florida v US Department of Health and Human Services. It is about the “individual mandate” (the requirement that every American purchase health insurance or suffer a financial penalty). I knew that there would be people who just wouldn’t get what it was that the Court had to decide. Sure enough one of the comments was:
Someone please explain how it is that we are mandated to have car/automobile insurance but cannot be mandated to health insurance??
The federal government is sovereign, but so are the fifty states. It is one of the fifty states that requires you to have car insurance and at least one of them, Massachusetts, tells me I have to have health insurance (Although the penalty like the penalty proposed under Obamacare is not all that onerous). The Eleventh Circuit was not ruling about whether it was a good idea to have an individual mandate. It was ruling on whether Congress had the power to make such a mandate. There are a lot of things that mask this constitutional reality from us in modern times like the Uniform Law Commission, which while having no power to make a state do anything, creates models of legislation that states pass, sometimes tweaking them first, so that the laws of the fifty states are very similar on many matters. Also Congress “encourages” states to do things by allocating federal money. That’s one of the mechanisms in the Prison Rape Elimination Act for example – (happens to be one of my favorites). Then there is the interstate commerce clause. Congress gets to regulate interstate commerce. The question the 11th Circuit had to deal with was whether not doing nothing (i.e. not buying health insurance) fell under that power.
Some people would think 51 sovereign powers would be enough but we are a nation largely descended from immigrants and people taken in captivity from other lands – largely. In the messy often ugly process of creating the nation a lot of deals were made with the indigenous peoples. In the latter half of the twentieth century more serious attention was paid to actually honoring those deals. Hey when your immigrant grandmother came from the Old Country and took the citizenship oath, she took on a lot of karma. Deal with it. At any rate you can add another 565 sovereign powers – federally recognized Indian tribes. Being sovereign is kind of cool. Nobody can sue you, unless you let them, and nobody can tax you. Of course, you can’t have 600 plus absolute sovereigns interacting with one another. All of them, including the United State of America, have limits on their sovereignty. When there are questions about the limits they sue one another. The suits tend to be in the courts of the United States of America, which, while some would argue sovereignty does not admit of degree, is the most sovereign of the bunch (It took many, many thousands of dead soldiers to establish that. A little flame bait for the neo-confederates there).
The FUTA Exception
So if you are working for an Indian tribe or the wholly owned subsidiary of a tribe, your employer does not have to pay FUTA on your wages. In this case the federal government argued that the exception only applies to common law employees not statutory employees. You see Mainstay was in the “employee leasing” business. The idea of employee leasing is to relieve employers of the administrative and compliance hassles of having employees. An employer is essentially outsourcing its payroll and human resources functions. All the employees become legally the employees of the “leasing company” which issues their pay checks, pays over their withholdings and explains their benefits and the like. The leasing company will take care of things like COBRA compliance, because for those purposes it is the employer now. It is a step beyond a simple payroll processing service. Still, the original employer directs the employees in the performance of their duties, tells them when to come in and when to go home and whether there is going to be clothing optional day in August. So the original employer may remain the “common law” employer while the leasing company is the “statutory” employer, a mere “paymaster”. Those concepts are a little fuzzy though.The district court had ruled that the FUTA exception for Indian tribes applied only to the employer of common law employees. The Ninth Circuit agreed:
We hold that § 3306(c)(7)’s exception unambiguously applies only where an Indian tribe acts as a common-law employer. The context of the exception—a subparagraph of the definition of “employment,” which incorporates the common-law element through the use of the term “employee”—compels this interpretation. Because we conclude that § 3306(c)(7) is not ambiguous, we do not apply the canon of construction requiring courts to resolve statutory ambiguities in favor of Indians. See South Carolina v. Catawba Indian Tribe, Inc., 476 U.S. 498, 506 (1986) (“The canon of construction regarding the resolution of ambiguities in favor of Indians … does not permit reliance on ambiguities that do not exist; nor does it permit disregard of the clearly expressed intent of Congress.”).
The Ninth Circuit was not finished though. They looked closely at the exact level of service and methods of operation of Mainstay and concluded that Mainstay was a common law employer:
Although the client, not Mainstay, supervised the leased employees on a day-to-day basis, the employees were required to comply with Mainstay’s employment policies regarding such issues as smoking, telephone use, timekeeping, and breaks. In this sense, the leased employees were subject to the will and control of both Mainstay and the client company. Moreover, Mainstay set the level of compensation and had ultimate responsibility for paying employees—if a client failed to pay Mainstay’s invoice, Mainstay paid the employees’ wages from its own bank account. Mainstay treated the leased employees as its own for tax purposes, issuing W-2 forms, withholding and remitting income taxes, and paying the employer portion of FICA taxes. Mainstay provided employment benefits, including health insurance, life insurance, and a 401(k) retirement plan. Under its contracts with clients, Mainstay retained the rights to recruit, screen, and hire employees for assignment at clients’ businesses; to terminate employees; to administer all unemployment claims; and to reassign employees to other clients if necessary. On several occasions, Mainstay defended against lawsuits brought by present or former employees arising out of their employment. All of these factors lead us to conclude that Mainstay was a common-law employer of its leased employees. The fact that Mainstay did not furnish tools or that the employees did not render their services on Mainstay property is not sufficient to tip the balance away from this conclusion.
So Blue Ranch is entitled to the refund of over 2 million dollars plus interest.
Exemption from the FUTA tax, which at most amounts to $56 per employee per year, is apparently not enough to give an employee leasing company an ironclad advantage, such that we will all be working for a tribe soon and FUTA will entirely dry up as a revenue source. According to news reports, Mainstay has been shut down because of liens from the State of California. The exemption from federal unemployment taxes is not an exemption from state unemployment taxes, which tend to be much more onerous than $56 per year. Employers, such as tribes and not-for-profits, that are exempt from FUTA can elect a reimbursement system rather than the insurance system that other employers are subject to. If you are running a small not for profit, this can be a tempting budget move, but I recomend you think real hard before doing it. I haven’t studied this aspect of the story closely, but this is apparently what bit Mainstay in the ass.
My Take on It As If That Matters
I have a rule that when I read cases I like to root for somebody. It makes it more interesting. Because of my professional bias, I usually root for the taxpayer. I’m not a lawyer but as a CPA I can represent taxpayers up to IRS appeals (If the case is big enough to be going beyond that, the lawyers will be in it at that point). Also if the taxpayer wins it might mean a clever idea that I can apply to one of my clients. On the other hand, if I think the taxpayer is being kind of lame, I put on my citizen hat and root for the IRS. This case was tough for me.
On the one hand, it appears from the news reports that Mainstay bounced its last paychecks and used its exemption to avoid taking responsibility for the unemployment claims of its former employees. Blue Rancheria is 53 people living on 91 acres. Mainstay employed 39,000 people in three states for many different businesses. It’s hard to see the need for it operating under different rules than Manpower or ADP. Is the position really consistent with Blue Rancheria’s mission statement:
The Blue Lake Rancheria Tribe strives each day to secure a better future for its people; to protect its sovereignty and cultural heritage; to respect, learn from, and correct injustices of the past; and to define an economic and diplomatic framework with its neighbors for mutually beneficial relationships.
Then I read the history. Here is a little piece:
Beginning on Indian Island, just offshore from Eureka in Humboldt Bay, a group of men silently attacked in the pre-dawn hours No distinction was made as to who were killed Over 200 mainly women, children and elders of area Wiyot andotherTribes were on the island to observe annual “World Renewal” ceremonies They had been there for a week, and most of the men had gone hunting to replenish food supplies Those remaining on the island were surprised as they slept, and killed with quiet weapons – axes, clubs andknives– in order to avoid detection by others on the mainland Two small groups of Yurok, two Wiyot women, and twelve children survived.
When Patrick Lyons arrived in America he was fleeing famine compounded by centuries of oppression and misrule. When he took the oath of citizenship he took on the karma from many of his now fellow countrymen not being the descendants of immigrants but rather people taken in captivity or displaced indigenous peoples like his ancestors. He got to put on a blue suit and march with the 22nd New Jersey through the mud. He was mustered out on June 22, 1863. At least according to the movie version thanks to John Buford and Joshua Chamberlain, he didn’t have to put the blue suit back on and die in the defense of Trenton. So his great-grandchildren can do things like blog for Forbes. They haven’t forgotten the famine in Ireland and there are even memorials to it in the cities of the Irish diaspora including the one in Boston. So I’m glad the Rancheria won the case, even though I think they really pushed tribal sovereignty to the outer limits and maybe beyond. The tribes’s sovereignty was part of the deal most of our ancestors signed up for when they took the oath of citizenship. It’s been a pretty good deal.