Daois u Michigan Department of Treasury: The Retroactivity Morass in Refunds of State Taxes

• Author: Major Linda K Webster
• Pages: 03

"It was as true,'' said Mr Barkas, " as taxes IS And nothing's truer than them."

Charles Dickens, Dewd Copperfield

I Introduction

In an early opinion by the United States Supreme Court, Chief Justice John Marshall wrote, "The power to tax involves the power to destroy"' That opinion, McCulloek o Maryland, 18 the foundation of the doctrine of intergovernmental tax immunity The doctrine provides some restraints upon actions by the federal and local governments to impose taxes that affect each other 2

Despite vigorous early litigation involving the doctnne,3 inter-governmental tax immunity appeared to be on the decline by the time of World War 11.

The Court rejected the reciprocal nature of the doctrine in Helueimg D. Gerhardt4 and began using the test of whether a tax was imposed even-handedly in a nondiscriminatory fashmn.6 The Court recently apphed the nondiscrimmstmn prong of the intergovernmental tax immunity doctrine in Davis L. Mtckbgon Department of Treasury The Court reviewed the taxpayer's argument that the Michigan state income tax violated the doctrine because the tax discriminated against federal retirees

'Judge Advocate General'r Corps. U S Army B A , 1978. University of Oklahoma, J D , 1981. Cmlsrmty of Texas, LLM . 1989 The Judge Advocate General's School This article LI based won a written them dissertation that the author submitted re the facult> ofthe Kafianal La- Center ai George Waahmson Unweri~fy ta mtxify, ~n part, the ~equmrnenrs far the dmee of hIa5ler of Lax.

-McCulloch \ Maryland. 17 U S (4 U h a t > 318. 431 l1819r'For a general discuiiion of the dactnne. see David M Richardaon FederalIneorna Tarrrlian of States 19 Srxraor L RE\ 411 11990)

'Le. @ E , Collector Y Day. 78 U S (11 Wall 1 113 (18701, Pollack v

'304 U S 406 11938)'Sea. e g , Graves v New York ex re1 OKeefo. 306 C S 466 (19391, South

'489 U S 803 119891

F ~ ~ ~ ~ ~ ~ '

L~~~ & h a t

c0, 157 O S 429 ii895i

Caralina 7 Baker 465 US 506 119881

The taxpayer also asserted that a federal statute' authorized states to tax a federal employee's pay only if the taxation did not discriminate against the employee because of the source of the pay.

This article will examine the Supreme Court's decision inDavis and the impact of the decision throughout states that had taxed federal retirees differently than state and local government retirees. It will review the tests for the retroactive application of a Umted States Supreme Court decision Finally, It will advance a theory for the resolution of Dmwrelated litigation in light of recent Court deemons regarding retroactivity and differential taxation of federal retirees and state and local government retirees

The author's position 18 that D a m c Miehtggon Departmentof Treosnrq applies retroactively based upon the United States Supreme Court's decisions in Chevron 0~1 Co I H ~ s o n , ~ Amnericon Trucking Associations, Innc ~1 Smith,g McKesson Corp

V . Diu~sion of Alcoholre Bmerages & and James B Beam Distdlrng Co. c Georgia.11 The question that is left open after these decisions 1s whether state procedural grounds-that 16,a State's refund statute-will operate to prevent plaintiffs in Dams-related cases from obtaining refunds after they successfully have challenged discriminatory state taxing statutea

11. The Supreme Court Speaks. Davis i' Michigan Department of TEaSUrq

In Doois o MtehLgnn Department of T~easury,lZ the United States Supreme Court examined a Michigan Statute that taxed the retirement benefits of federal government retirees differently

-4 US C S 111 ,1988) (also known a& the Pvblic Salary Tar Act)

&404 D S 97 (1971'196 LT S 167 ,1990: -O496 US 18 '19901 --111 S Ct 2439 11991,

1489 US 803 11989) remanded 446 S K 2 d 631 11989: See generally. Rxhardran, supra note 2, ~f 424-446 Roberr J Mlueller Note Rgeclion of the "5sm~iailv Sztuoted Toroovd' Rotronnfe Da\m v Mzehiesn Demrtmenf of

. , " .

Treasury 43 Tax L.N 431 (19901 Timothy B Sherman, Note. Davis \ Michigan and the Doctrine of Retroactivity States' Refund Liability for Taxation of Federal Pension Incame 4 BY U J Prs L 507 ,19901. Martin A U'eeka. Kate. Tarotion Remedm far D~rcriminalory Staa Taxation a/ Federal Pensroneis after Davis x Michrgan Department af Treasury, 43 Om.& L Rri 565 119908

than the retirement benefits of State government retirees.13 The Court held that the Michigan tax statute violated the principles of the intergovernmental tax immunity doctrine and the Public Salary Tax Act because of the discriminatory treatment of federal retirees based upon the source of their retirement incomes The dissent disagreed with the majority conclusion and instead reasoned that when the tax burden under a state taxing scheme is shared equally by federal employees and most other state residents, no discrimination arises against the federal employees.

1. Facts and Hwtory

   Appellant Paul S D a ~ s was a Michgm resident and a former

   federal employee He received retirement benefits based on the Ciml Semce Retirement Act.14 For each year from 1979 though 1984, Dams paid Michigan state income tax on hus federal retirement benefits as required by Michigan law 16 The statute exempted the retirement benefits of retired state employee8 while tmng the retirement benefits of federal employees.

   Davis onginally petitioned the state for a refund of the taxes he pad on his retirement benefits from 1919 through 1983. The state denied the refund, and Davis tiled suit m the Michigan Court of Claims. Davis added the 1984 tax year's payments to his complaint. Davis alleged that Michigan's incanaistent tax treatment of retirement benefits discriminated against federal employees in violation of the Public Salary Tax Act, which preserved federal employees' Immunities from discriminatory state taxatian.16

   ~~

   "MICH C o w L*ws AYK 5 206 30(lrlP (Went Svpp 19881 In pertinent

   means adlusted gross income as denned

   ~n the ~nternal revenue code subject to the following adwatments

   part, the statute pravlded

   Ill Taxable income

   iFI Deduct to the extent inrlvded m adlusted maas mnme (1) Retirement or penman benefila received from a public retirement Bystem of or created by an act of this stale or B pihcal rubdmsmn ai fhls state

   (>vi Retirement 07 penlion benefits from any other retirement 01 penslo" 'y'tem as follawa

   !A) For a a~ngle return. the eum of naf more than 87.600 00(Bi For B j a m return the BY^ of not more than s10 000 00"5 us c. 3 3331 (1938,

   The Michigan Court of Clams denied relief,'7 and the Michigan Court of Appeals affirmed 18 The Court of Appeals determined that Davis was an "annutant" under federal law instead of an "employee" within the meanmg of the Public Salary Tax Act because Daws was B "former employee who meets all the requirements to receive an annuity ''lS Therefore, section 111 of the Public Salary Tax Act did not apply to Davis. The Court of Appeals also held that the doctrine of intergovernmental tax ~mmumty did not render the Mlchlgan taxmg scheme unconatitutional because the discrimination was justified under a rational-basis test.20 In this case. the state's interest was to attract and retain qualified employees, which was a "legitimate state objective which IS rationally achieved by a retirement plan offering economic inducements ''21

   The Michigan Supreme Court denied Davis' application for leave to and the Umted States Supreme Court noted probable jurisdiction.23

   B The Majont) Oprn~on

   The Supreme Court held that the Michigan Income Tax Act violated the principles of intergovernmental tax mmunity and section 111 of the Public Salary Tax Act by favoring state and local government retirees over federal government retirees In arriving at this canclusmn, the Court examined whether the statute applied to federal retirees, whether the statute ws coextensive with the doctrine of intergovernmental tax immunity. and whether the provisions of the Michigan Income Tax Act violated the principles of intergovernmental tax immunity

   Justice Kennedy wrote the opinion for the majority. The State argued that section 111 applied only to Current employees of the federal government and not to retirees Justice Kennedy rejected this argument, stating that the plain language of section 111 applies to retirees also Acknowledgmg that mvd service retirement pay is based and computed upon an individual's salar) and veers of service. Justice Kennedy concluded that civil serwce

   retirement benefits are deferred compensation representing previous years of service to the federal government Therefore, because these benefits accrue to an employee based on his or her service to the federal government, they are compensation far

   S I I V ~ S rendered a8 an officer or employee of the United States as required by section 11124

   Justice Kennedy called the State's argument that the nondiscrimination clause applied only to current federal employees "hypertechnical" and "construed in a vacuum "25

   Relying on the doctrine of statutory construction, Justice Kennedy stated that the reference to "the pay or compensation" in the last clause of section 111 must mean the Same "pay or compensation" defined in the first clause of the section. Arguing that nothing in the statute 01 Its legislative history supported the State's interpretation of section 111, Justice Kennedy stated that section 111 "waives whatever immunity past and present federal employees would otherwise enjoy from &ate taxation of salaries, retirement benefits, and other forms of compensation paid on account of their employment with the Federal Government, except to the extent that such taxation discriminates on account of the source of the compensation "25

   Justice Kennedy also addressed the issue of intergovernmental tax immunity. Intergovernmental tax immunity is a doctrine that originated in McClilloeh U. Maryland 27 McCulloeh held that the State of Maryland could not impose a discriminatory tax against the Bank of the United States because the Bank was an instrumentality of the United States...