In its 2019 Spring Term, the Supreme Court published five decisions regarding tax matters, three of which limit states' taxing authority. In a February decision, Dawson v. Steager, the Court held that a state cannot tax a federal retiree's pension benefits while declining to tax a similarly situated state retiree. The March decision in BNSF Railway Co. v. Loos held that lost wages paid to a worker who was injured on the job constitute taxable compensation under the Railroad Retirement Tax Act. Later in March, the Court held in Washington State Department of Licensing v. Cougar Den that a state tax imposed on a member of the Yakama Nation on importation of fuel via public highway is pre-empted by the 1855 Treaty Between the United States and the Yakama Nation of Indians. Then, in May, in Franchise Tax Board of California v. Hyatt, the Court held that a state may not be sued in another state's court in a private suit, unless it waives immunity. Finally, the Court issued its decision in North Carolina Department of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, covered in a separate Disputing Tax post available here.
Dawson v. Steager, 586 U. S. ____ (2019)
In Dawson v. Steager, the Supreme Court unanimously held that a state may not impose tax on pension payments to retired federal law enforcement officers while affording tax exemptions to retired state law enforcement officers. The petitioner, James Dawson, is a retiree from the U.S. Marshals Service, who received retirement income from the Federal Employee Retirement System. Under a state law, W. Va. Code Ann. §11- 21-12(c)(6), West Virginia exempted state retirement income its residents received from West Virginia police; West Virginia Firemen's Retirement System; the West Virginia State Police Death, Disability and Retirement Fund; the West Virginia State Police Retirement System; or the West Virginia Deputy Sheriff Retirement System. Dawson amended his tax returns for 2010 and 2011 to claim the exemption under the state law, but the state denied the exemption. Dawson appealed, alleging that the state violated the inter-governmental tax immunity doctrine of 4 U.S.C. §111, which prohibits discriminatory state tax based on the source of federal employees' pay or compensation. Specifically, under 4 U.S.C. §111, the U.S. consents to state taxation of the "pay or compensation" of "officer[s] or employee[s] of the U.S." only if the "taxation does not discriminate against the officer or employee because of the source of the pay or compensation." Therefore, a state violates this law when it treats retired state employees more favorably than retired federal employees while no "significant differences between the two classes" exist to justify the differential treatment.1 On this ground, the Court had previously invalidated Kansas tax that discriminated against federal retirees.2
In Dawson, the state argued that the exemption for state and local law enforcement pensions was not discriminatory because it impacted a de minimis number of retirees, did not meaningfully interfere with federal government operations, and was not intended to harm federal retirees. The Court rejected these arguments and held that if the state exempts only a narrow subset of retired state employees, the state can still be compliant with 4 U.S.C. §111 by exempting the comparable class of retired federal employees. Further, the Court held that in evaluating whether a state law is discriminatory, the state interest in adopting such law is "simply irrelevant."3 The Court also stated that the focus of the inquiry is whether federal retirees are similarly situated to state retirees who do receive tax breaks, not those who do not. The Court interpreted "similarly situated" as performing comparable duties.4 In response to the state's assertion that the distinction may be based on the relative generosity of pension benefits, the Court held that the West Virginia statute, as it is enacted, does not draw distinction on such basis and thus discriminates based on the source of payment. The Court further articulated that where there is an explicit unlawful classification in the text of the statute, a lawful, but implicit, classification does not render the statute lawful. However, the Court did not adopt a bright line rule on whether the federal retirees were "similarly situated" and performed comparable duties, and remanded the case.
The decision's immediate impact is that if a federal employee's job responsibilities were similar to a comparable state employee's, the state may not tax the federal pay or compensation without doing the same to state pay or compensation. However, the question remains as to how courts will determine whether federal employees or retirees are similarly situated to state employees. It is also unclear whether the decision will actually benefit federal retirees, or whether states with similar statutes will choose to instead tax state retirees.
For its part, West Virginia must take action. First, it may have to issue refunds to some federal retirees who submit valid refund claims if their job responsibilities were similar to the petitioner's and they had already paid the taxes on their pension income. Prospectively, West Virginia may repeal the exemption for retired state employees or exempt the retirement benefits of similarly situated federal employees.
BNSF Railway Company v. Loos, 586 U.S. ____ (2019)
In BNSF Railway Co. v. Loos, the Supreme Court held that lost wages paid to a worker who was injured on the job constitute "compensation" under the Railroad Retirement Tax Act (RRTA), because the definitions of "compensation" in the RRTA and "wages" in the Federal Insurance Contribution Act (FICA) and the Social Security Act (SSA) are similar. Loos, who was injured on the job, sued BNSF Railway Company under the Federal Employers' Liability Act for withholding $3,765 of taxes from the $30,000 of lost wages awarded to him. Lower courts held that awards to injured railroad workers for lost wages are not taxable under the RRTA. Thus, the issue before the Court was whether payment of lost wages due to a railroad worker's on-the-job injury is taxable "compensation" under RRTA.
Even though compensatory damages for physical injuries are excluded from gross income under §104 of the Internal Revenue Code, the RRTA imposes a separate tax on "compensation." The RRTA and Railroad Retirement Act (RRA) define "compensation" as "any form of money remuneration paid to an individual for services rendered as an employee."5 This is similar to how FICA and the SSA define "wages," as "all remuneration" for "any service, of whatever nature, performed...by an employee."6 Under both systems, the taxes and benefits are measured by an employee's "wage" or "compensation." The Court concluded that the definitions of "wages" and "compensation" are materially indistinguishable, relying on earlier cases interpreting "wages." In the past, the Court has held that other types of employment-related payments constituted "wages."7 In line with this precedent, the Court held that "compensation" under RRTA and RRA includes payment for periods of absence from service, regardless of whether the employer chooses to make it or is legally required to do so.
The narrow impact of the decision is that settlement awards of lost wages for railroad employees will be taxable, and railroad employers must withhold on them. More broadly, the opinion signals that settlement payments for work-related injuries that are allocated to lost wages will be taxable, though the Internal Revenue Code explicitly exempts workers' compensation payments from the FICA tax.8
1 Dawson v. Steager, 586 U.S. ___, at *3, quoting Davis v. Mich. Dept. of Treasury, 489 U.S. 803, 816 (1989) (invalidating a tax on former federal employees' retirement benefits).
2 See Barker v. Kansas, 503 U.S. 594, 599 (1992) (invalidating a tax on federal military retirement benefits).
3 Dawson, 586 U.S. ____, at *5, citing Davis, 489 U.S. at 816.
4 586 U.S. at *6.
5 IRC §3231(e)(1); 45 USC §231(h)(1)
6 IRC §3121(a)-(b); 42 USC §§409(A), 210(a).
7 Social Security Bd. v. Nierotko, 327 U.S. 358 (1946) ("wages" include payment for active service as well as periods of absence from service, including back pay for lost wages due to the employer's wrongful conduct); United States v. Quality Stores, Inc., 572 U.S. 141 (2014) (under FICA, "wages" include severance payments).
8 IRC § 3121(a)(2)(A); Treas. Reg. § 31.3121(a)(2)-1(a).
To view the full article click here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.