Jamie C. Yesnowitz
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On Feb. 20, 2019, the U.S. Supreme Court decided Dawson v. Steager
in which it struck down a West Virginia law exempting the pension benefits of state and local law enforcement employees from state taxation. In a unanimous opinion, the Court ruled that the West Virginia tax exemption unlawfully discriminates against federal law enforcement officers because it treats retired state employees more favorably than similarly situated retired federal employees.
Petitioner James Dawson, a West Virginia resident, worked in the U.S. Marshals Service. Upon retirement, Dawson discovered that while his pension benefits were subject to West Virginia income tax, the same pension benefits of law enforcement employees working for the state of West Virginia that performed similar duties were exempt from tax.2
Dawson brought suit under 4 U.S.C. Sec. 111, which allows states to tax the compensation of federal officers and employees, but only if the “taxation does not discriminate against the officer or employee because of the source of the pay or compensation.”3
The federal law was adopted by Congress to codify the intergovernmental tax immunity doctrine, which found its origins in the Supremacy Clause of the U.S. Constitution4
and was developed through U.S. Supreme Court case law to bar discriminatory state taxes.5
A state violates Sec. 111 when it treats retired state employees more favorably than retired federal employees and no “significant differences between the two classes” justify the differential treatment.6
Agreeing with Dawson, the West Virginia trial court found no significant differences between Dawson’s job duties as a federal marshal from those of the state and local law enforcement officers exempted from taxation, and found that the state law violated Sec. 111’s antidiscrimination provision. Reversing the trial court, the West Virginia Supreme Court of Appeals concluded that the state tax exemption applies only to a narrow class of state retirees and was never intended to discriminate against federal retirees. The U.S. Supreme Court granted certiorari
due to the inconsistent results reached by state courts in this area of state taxation.
Unlawful discrimination against federal employees
In an opinion authored by Justice Neil Gorsuch, the Court held that West Virginia’s law unlawfully discriminates against Dawson because it affords state law enforcement retirees “a tax benefit that federal retirees cannot receive.” Agreeing with the state trial court, the Court found no significant differences between Dawson’s job responsibilities as a U.S. Marshal and those of tax-exempt state law enforcement retirees. The Court rejected West Virginia’s argument that the exemption affects too small a class to meaningfully interfere with federal government operations. In response, the Court emphasized that Sec. 111 disallows any
state tax that discriminates against a federal officer or employee, not just those that seem especially burdensome.
The Court next addressed West Virginia’s argument that its law was intended to help certain state retirees rather than harm federal retirees. Strictly construing the language of Sec. 111, the Court found that a state’s interest in adopting a discriminatory tax is “simply irrelevant” because it ignores the treatment of the two classes of employees.
Assuming that treatment is what matters, the state argued that its law was not discriminatory because there were significant differences between the two classes, retired U.S. Marshals and state law enforcement retirees. But the West Virginia statute did not draw any such lines in defining the favored class. In fact, the state law singled out for preferential treatment pension benefits associated with West Virginia police, firefighters and deputy sheriffs. The distinguishing characteristic of the retirement plans is the nature of the jobs previously held by retirees who may participate in such plans. The Court concluded that there were no significant differences between Dawson’s former job responsibilities as a U.S. Marshal and those of the state law enforcement retirees qualifying for the tax exemption.
While West Virginia attempted to make the distinction that a federal employee’s job responsibilities were also similar to that of other state law enforcement employees who did not qualify for the tax exemption, the Court said that was not the focus of the inquiry: “the relevant question isn’t whether federal retirees are similarly situated to state retirees who don’t
receive a tax benefit; the relevant question is whether they are similarly situated to those who do
Finding that both classes of employees are similarly situated, the Court concluded that the West Virginia law operated to discriminate against Dawson because of the source of his compensation. Reversing the decision of the West Virginia Supreme Court of Appeals, the Court remanded the case to the West Virginia trial court to determine the appropriate remedy.
In a relatively short decision by recent Court standards, the Court unanimously invalidated the West Virginia tax exemption solely on the grounds of violating a federal statute, a codification of the intergovernmental tax immunity doctrine, which dictates how states may tax government workers. Interestingly, it was unnecessary for the Court to analyze the validity of the tax under Complete Auto Transit v. Brady
, the seminal case used to determine whether a state tax will withstand scrutiny under the Commerce Clause of the U.S. Constitution.8
Nor did the Court find it necessary to examine the statute under a Due Process Clause analysis.
The Court left it to the state trial court to determine the appropriate remedy in this case. That court will need to decide whether federal law enforcement retirees like Dawson will be entitled to a similar tax exemption as state law enforcement officers, or whether the exemption should be disallowed for the state retirees currently receiving the tax benefit. In the longer term, West Virginia also has the option of doing away with the state statute altogether, thus denying the exemption to former state law enforcement officers. One would expect that to the extent the revenue impact of including federal law enforcement retirees is not significant, as a matter of public policy, the state likely would opt for a more inclusive exemption covering Dawson and similarly situated individuals.
In the near term, the Dawson
case provides additional clarity to states with laws that attempt to provide preferential tax treatment to certain classes without discriminating against others. States may use the analytic framework provided in Dawson
to evaluate the legality of their current laws that may favor one class over another with respect to the tax exemptions provided. Further, states now have a roadmap to adopt tax exemptions that more carefully define a class of persons in order to avoid running afoul of intergovernmental tax immunity.
Although the Court decided the limited question of whether West Virginia could exempt state law enforcement officers’ retirement income from state taxation without providing the same exemption to the benefits of U.S. Marshals, the Court’s decision could have much wider implications in the longer term. For example, a handful of other states have similar laws on the books allowing preferential tax treatment for certain retirees. As many as 2.6 million federal retirees may be affected by the Court’s decision if found to apply to other state tax laws.9
Finally, the true reach of the Court’s ruling may extend beyond the personal income tax regimes, with potential implications for other types of state tax laws designed to favor one class over another.
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