Kentucky and Tennessee succeed in ARPA challenge


On Sept. 24, 2021, a Kentucky federal district court granted Kentucky and Tennessee a permanent injunction from application of a controversial spending restriction on funds provided to the states in the American Rescue Plan Act (ARPA)1 by the federal government, finding it to be a coercive grant of federal money.2 The decision follows a similar conclusion by an Ohio federal district court.3






In an effort to mitigate the economic impact of the COVID-19 pandemic, ARPA created Coronavirus State and Local Fiscal Recovery Funds for distribution to state and local governments. Under ARPA, states are required to use the funds for either a wide variety of pandemic-related purposes, or to make necessary investments in water, sewer or broadband infrastructure.4

The ability to use the funds is restricted by ARPA in several ways. First, the states are prohibited from using the funds to offset a reduction in the state’s net tax revenue resulting from a change in law, regulation or administrative interpretation during a “covered period” that reduces any tax, or from depositing the funds into a pension fund.5 The “covered period” began on March 3, 2021, and ends on the last day of the fiscal year in which the funds are used or returned to the federal government.6 Further, to receive the funds, the states are required to comply with a variety of certification and reporting requirements, and the federal government has the right to recoup the funds if the states do not comply with the ARPA restrictions.7 In response to numerous requests for more specific guidance regarding the scope of the restrictive provision (termed the “tax mandate” in the litigation at issue), the U.S. Treasury Department adopted interim rules designed to provide further guidance to states regarding when the ARPA tax mandate would be triggered.8

Kentucky and Tennessee filed suit for relief from the law in federal court, seeking both a declaratory judgment finding the ARPA tax mandate unconstitutional and requesting a permanent injunction.




District Court decision


In their filing, Kentucky and Tennessee set forth assertions regarding both standing and constitutional arguments. Specifically, they contended that they met the standing threshold on the grounds that the tax mandate: (i) unconstitutionally narrows the range of permissible tax policies that states may enact; and (ii) imposes administrative burdens. As to their constitutional concerns, they asserted that the mandate: (i) is unconstitutionally ambiguous and coercive in violation of the Spending Clause; (ii) is not reasonably related to the federal interest in passing the ARPA; and (iii) violates the anticommandeering doctrine. In response, the federal government asserted that Kentucky and Tennessee lack standing, that the case is not ripe, and that Congress has not exceeded the bounds of its authority for Spending Clause purposes.





As a matter of threshold inquiry, the court began its analysis by addressing the issue of standing. To satisfy the requirement, a plaintiff must generally demonstrate that it has suffered an injury-in-fact. Upon considering previous U.S. Supreme Court decisions addressing pre-enforcement challenges, the court noted that “an allegation of future injury may satisfy the injury-in-fact requirement if the alleged threatened injury is certainly impending, or there is a substantial risk that the harm will occur.”9 Specifically, the injury-in-fact requirement is met where plaintiffs allege three factors: (i) an intention to engage in a course of conduct arguably affected with a constitutional interest; (ii) that is proscribed by law; and (iii) a credible threat of prosecution exists.10

The court quickly and concisely disposed of each issue. First, based on the recent Ohio federal district court decision addressing ARPA, the court found at least one valid argument that the tax mandate is unconstitutional.11 Next, it found the second factor satisfied because the tax mandate may fairly be considered a guardrail as to how states may spend ARPA funds. Finally, as Treasury Secretary Yellen has indicated in a letter that she intends to enforce the law,12 it confirmed the existence of a credible threat of prosecution. Based on these conclusions, the court found that Kentucky and Tennessee adequately established standing, allowing the court to focus on the merits of the case.



Constitutional violations


The first substantive issue considered by the court related to whether the tax mandate was unconstitutionally coercive under the Spending Clause. In exercising its spending power, Congress must abide by certain limitations.13 In prior U.S. Supreme Court decisions addressing possible coercion, the court observed that one significant determining factor was whether the states alleging the tactic might realistically refuse to accept the money if they did not accede to the conditions.14 In this instance, the ARPA funds represent roughly 20% of the annual state tax collections brought in by state governments.15 At the same time, state and local governments, including Kentucky and Tennessee, have borne significant economic costs associated with the COVID-19 pandemic. Given the “choice” of whether to accept the federal ARPA funds, the court determined that under the circumstances, the jurisdictions had no voluntary or knowing choice as to whether to accept the funds. Thus, it found the tax mandate to be coercive, and as such, the condition could not be sustained. The court noted that when the federal government unduly influences the states’ power to set their own tax policies, it oversteps its bounds. Finding the tax mandate unconstitutional and coercive in violation of the Spending Clause, the court declined to address three other constitutional violations raised by Kentucky and Tennessee.



Appropriate remedy


Turning to the issue of an appropriate remedy, the court considered Kentucky and Tennessee’s request for both declaratory relief and a permanent injunction enjoining the Treasury Secretary from enforcing the tax mandate provision of the ARPA. Because it found that Kentucky and Tennessee clearly suffered violations of their constitutional rights due to the coercive nature of the law, the court focused on the following established factors to determine the appropriateness of a permanent injunction: (i) whether they suffered an irreparable injury; (ii) remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (iii) an equitable remedy is warranted upon considering the balance of hardships between the parties; and (iv) the public interest would not be disserved by a permanent injunction.16 Finding all four conditions adequately satisfied, the court found a permanent injunction appropriate, and declined to address the issue of a declaratory judgment.



Scope of injunction


Finally, the court considered the scope of its injunction, as the ARPA tax provision affects every state in the country. The court evaluated whether it should enjoin enforcement of the provision for: (i) the Eastern District of Kentucky (i.e., the court’s district); (ii) Kentucky and Tennessee (the plaintiffs); or (iii) all states via a universal injunction. Citing language from U.S. Supreme Court decisions addressing the increasing frequency of universal injunctions,17 the court expressed its preference to allow legal questions to percolate through the federal court system. Generally following the approach taken by the recent Ohio federal district court decision addressing the same issue and reaching a similar conclusion granting injunctive relief only to Ohio,18 the court likewise limited the scope of the permanent injunction to apply to Kentucky and Tennessee.






With this decision, the U.S. District Court in Kentucky joins its Ohio counterpart in declaring the ARPA tax mandate unconstitutional and providing a permanent injunction for the jurisdictions bringing suit. It is interesting to note that although both courts similarly concluded in favor of the states, their analysis regarding the constitutionality of the law was quite distinct. While the Kentucky court focused on whether the mandate was coercive, the Ohio court evaluated its adherence to the clarity requirement under the Spending Clause. There is little overlap in the courts’ rhetoric addressing the merits of the issue. With several similar outstanding lawsuits from states having brought legal action challenging the ARPA tax mandate currently sitting in the federal courts,19 it will be interesting to observe whether they focus on these same Spending Clause requirements or focus on other constitutional arguments to reach conclusions.

Of crucial importance to this decision was the fact that Kentucky and Tennessee (like most states) were not in a position to refuse the federal funds offered by ARPA. As states continue to emerge from the immediate economic impact of the ongoing pandemic and evaluate its effect on their future financial health, it is difficult to imagine any scenario under which such funds could be realistically rejected. With the release of this second U.S. District Court decision declaring the tax mandate provision unconstitutional and the other currently outstanding challenges, the focus may now turn to whether, and if so when, the Treasury Secretary will provide further guidance regarding the mandate and how it will be enforced. Given the distinctive and compelling sovereignty issues raised by the ARPA tax mandate and the effect that the mandate could have on future state taxation policies, it may only be a matter of time until the ARPA tax mandate controversies are raised before the U.S. Supreme Court.


1 P.L. 117-2 (2021).
2 Commonwealth of Kentucky, et al v. Yellen, United States District Court for the Eastern District of Kentucky, Central Division, Case No. 3:21-cv-00017-GFVT-EBA, Sept. 24, 2021.
3 Ohio v. Yellen, United States District Court for the Southern District of Ohio, Western Division, Case No. 1:21-cv-18, 2021 U.S. Dist. LEXIS 123008, July 1, 2021. See GT SALT Alert: Ohio Granted Permanent Injunction from ARPA Tax Cut Provision.
4 Social Security Act, Title VI, 42 U.S.C. § 802(c)(1).
5 Social Security Act, Title VI, 42 U.S.C. § 802(c)(2).
6 Social Security Act, Title VI, 42 U.S.C. § 802(g)(1). As the funds obtained from ARPA must be spent by December 31, 2024, the ending date of the covered period could extend for several years.
7 Social Security Act, Title VI, 42 U.S.C. § 802(d), (e).
8 31 C.F.R. Part 35, RIN 1505-AC77, “Coronavirus State and Local Fiscal Recovery Funds.” The guidance notes that three sources potentially could offset a prohibited reduction in net tax revenue: (i) organic growth; (ii) increases in revenue; and (iii) certain types of spending cuts. In addition, the interim guidance confirms that a reduction in net tax revenue could result from any “covered change,” including a change in law, regulation or administrative interpretation. Notably, a covered change does not include a change that cannot be controlled by the state, or income tax changes simply conforming to changes in federal law.
9 See Susan B. Anthony List v. Driehaus, 573 U.S. 149 (2014).
10 Id.
11 Ohio v. Yellen, United States District Court for the Southern District of Ohio, Western Division, Case No. 1:21-cv-18, 2021 U.S. Dist. LEXIS 123008, July 1, 2021.
12 Treasury Secretary Janet L. Yellen Response to State Attorneys General Inquiries on Implementation of Section 9901 of the American Rescue Plan Act (Mar. 23, 2021).
13 See National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), quoting Steward Machine Co. v. Davis, 301 U.S. 548 (1937). Congress may encourage a state to regulate in a particular way and exert influence, but oversteps its powers when “pressure turns into compulsion.”
14 See South Dakota v. Dole, 483 U.S. 203 (1987) and National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012).
15 See Four Questions Treasury Must Answer About the State Tax Cut Prohibition in the American Rescue Plan Act, Jared Walczak, Tax Foundation (Mar. 18, 2021).
16 See eBay Inc. v. MercExchange, LLC, 547 U.S. 388 (2006).
17 See Trump v. Hawaii, S. Ct. 2392 (2018).
18 Ohio v. Yellen, United States District Court for the Southern District of Ohio, Western Division, Case No. 1:21-cv-18, 2021 U.S. Dist. LEXIS 123008, July 1, 2021.
19 In addition to Ohio, Kentucky, and Tennessee, the states of Arizona, Missouri, Texas, and West Virginia have challenged the ARPA tax mandate provisions. For an issue paper addressing current challenges to ARPA, see Joseph Bishop-Henchman, National Taxpayers Union, “Six Lawsuits Filed to Challenge ARPA Ban on State Tax Cuts,” June 3, 2021.






This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.


More SALT alerts