Bohn v. Waddell, TX

• Decision Date: 06 April 1990
• Docket Number: No. TX,TX
• Citation: 164 Ariz. 74,790 P.2d 772
• Parties: John L. BOHN, et al. v. Paul WADDELL, et al. 89-00050.
• Court: Arizona Tax Court

Page 772

790 P.2d 772

164 Ariz. 74

John L. BOHN, et al. v. Paul WADDELL, et al.

No. TX 89-00050.

Tax Court of Arizona.

April 6, 1990.

[164 Ariz. 79] Bonn & Jensen, Chartered by Robert A. Jensen, Brian A. Luscher, Phoenix, for plaintiffs-appellants.

Eugene O. Duffy, Milwaukee, Wis., for plaintiffs-appellants.

Atty. Gen. by William D. Hostetler, Gail H. Boyd, Phoenix, for defendants-appellees.

OPINION

MARONEY, Judge.

On March 28, 1989, the United States Supreme Court rendered its decision in Davis v. Michigan Department of Treasury, 489 U.S. 803, 109 S.Ct. 1500, 103 L.Ed.2d 891 (1989). The Davis decision held, as contrary to federal law, certain provisions of Michigan law governing state taxation of income. Michigan imposed a tax on the pension benefits of federal retirees, while exempting from tax similar benefits enjoyed by State of Michigan pensioners.

There are five Plaintiffs herein. Two are retired United States military pensioners, one is a retired United States civil service pensioner, and two are spouses of the military retirees.

On May 1, 1989, Plaintiffs filed suit against the Director of the Department of Revenue, and all former Directors back through 1985. Plaintiffs alleged violations of 42 U.S.C. § 1983, and sought certification of a Plaintiff class of all federal pensioners who paid income tax to Arizona since 1985. The complaint sought a declaration of unconstitutionality, injunctive relief, and damages measured by taxes paid to Arizona on federal pensions. The complaint, as first filed, did not name the State as a Defendant, nor did it make a claim for a tax refund.

Later, the complaint was amended to add a second count alleging as unconstitutional the statute by which Arizona taxed the Plaintiffs' federal pensions. The Department of Revenue was named as a Defendant. On the basis of this count, the Plaintiffs continue to press for a declaration of unconstitutionality, class certification, and injunctive relief. They also seek a refund of all taxes paid on federal pensions from 1984 on. In the amended complaint, the original complaint is repeated as Count 1. Both the original complaint, and the amended complaint are based on the Davis decision.

For all of the tax years material to the issues before the bench, Arizona gross income is equal to federal adjusted gross income. To determine Arizona adjusted gross income, subtractions authorized in A.R.S. § 43-1022 are made to Arizona gross income. Arizona adjusted gross income is further refined into Arizona taxable income, upon which Arizona income tax is assessed. As a result of the foregoing scheme, subtractions taken pursuant to A.R.S. § 43-1022 are exemptions from Arizona State income tax.

When the Davis decision was announced, A.R.S. § 43-1022(3) provided for a subtraction for all benefits from Arizona State retirement systems, and A.R.S. § 43-1022(4) provided for a subtraction for up to $2,500 of income from United States civil service retirement. There was no subtraction provided for pension benefits from any federal retirement program other than civil service. Military retirement income was not exempted from Arizona income tax, neither in whole nor in part.

Shortly after the Davis decision was announced, the Arizona legislature amended A.R.S. § 43-1022 to provide a subtraction for up to $2,500 of income from all federal pensions and all state pensions. Laws, 1989, ch. 312 § 12, 1989 Ariz.Legis.Serv. 1604 (West). The subtraction previously allowed in A.R.S. § 43-1022(3) was repealed. This legislative change reduced the subtraction for state pensions and instituted a subtraction for non-civil service federal pensions so that all federal and state pensions are now treated the same. The amendment to A.R.S. § 43-1022 is effective for the tax year 1989 and subsequent years.

It is safe to say that the legislature was motivated by the Davis decision to make the change that it made to A.R.S. § 43-1022. It was the intent of the amendment to reform Arizona law so that it would comply with what was mandated by Davis: that is, that both federal and state pensions be treated the same.

The Court declares that the scheme for taxing federal and state pensions, as existed before the recent amendment to A.R.S. § 43-1022, was in violation of federal law, and further, was in violation of the federal constitutional doctrine of intergovernmental tax immunity.

The Court grants summary judgment to all Defendants on Count 1, holding such Defendants have an immunity from suit under 42 U.S.C. § 1983 because the acts complained of were all done in the performance of official duty, and the Plaintiffs' rights were not clearly established before the Davis decision.

The Court grants summary judgment to the Plaintiffs and against the Department of Revenue on Count 2 and makes such further orders in resolution of the Plaintiffs' suit as are reflected in this decision and in the Court's minute order of the same date.

The Court further holds that the Plaintiffs need not exhaust administrative remedies before bringing suit in this Court, and that Plaintiffs have failed to demonstrate the need for injunctive relief.

Pursuant to A.R.S. § 12-1841 and the doctrine of virtual representation, the Court directs the Department of Revenue to treat all persons who paid Arizona income tax on federal pensions for tax years 1984 through 1988 as though each such person were a Plaintiff herein. Because of the foregoing, the Court holds that certification of a Plaintiff class is neither necessary nor expedient.

The Department of Revenue is directed to refund a portion of Arizona income taxes paid by each Plaintiff, and all persons similarly situated, according to the following formula. In addition to the tax refund directed herein, the Department is to pay interest to each taxpayer at such rates as the Department pays when income tax overpayments are refunded.

To determine the amount of the refund due the taxpayer, two computations must be made. The first step is to multiply .0275 times the highest Arizona tax rate paid, times the taxpayer's federal pension income. If income has been subtracted pursuant to A.R.S. § 43-1022(4), the amount of such income multiplied by the taxpayer's highest Arizona rate must be subtracted from the amount determined in step one. No more tax can be refunded than was paid.

Refunds are to be made for tax years 1984 through 1988. Applications for such refunds may be made up until the first April 15th two years after this decision becomes final or until the expiration of the term provided in A.R.S. § 42-115, whichever is later.

In the balance of this opinion, the Court will discuss in detail the facts determined, and the law which applies.

Application of the Decision in Davis to the Arizona Scheme

Paul Davis, a resident of Michigan, received retirement benefits pursuant to the United States Civil Service Retirement Act. Michigan defined taxable income in a manner that excluded all retirement benefits received from the state or its political subdivisions, but included federal retirement benefits. Davis sued the Michigan Department of the Treasury for "refunds of state taxes paid on his federal retirement benefits." Davis, 109 S.Ct. at 1503.

Davis claimed that the state's inconsistent treatment of state and federal retirement benefits discriminated against federal retirees in violation of 4 U.S.C. § 111. The United States Supreme Court, in an opinion written by Justice Kennedy, agreed with Davis.

4 U.S.C. § 111 was enacted as part of the Public Salary Tax Act of 1939. The purpose of the Public Salary Tax Act was to provide for federal income taxation of the salaries of state and local government employees. 4 U.S.C. § 111 states:

The United States consents to the taxation of pay or compensation for personal service as an officer or employee of the United States, a territory or possession or political subdivision thereof, the government of the District of Columbia, or an agency or instrumentality of one or more of the foregoing, by a duly constituted taxing authority having jurisdiction, if the taxation does not discriminate against the officer or employee because of the source of the pay or compensation.

Justice Kennedy said the meaning of 4 U.S.C. § 111 is "unmistakable."

It waives whatever immunity past and present federal employees would otherwise enjoy from state 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.

Davis, 109 S.Ct. at 1505.

In analyzing the Davis opinion, one needs to consider that the typical American wage earner is subject to two governments, one the state, and one the United States. The immunity to which Justice Kennedy refers is an immunity from taxation by one government once enjoyed by the employees of the other government. This immunity was established as a corollary of the doctrine of intergovernmental tax immunity, a doctrine first advanced in McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 4 L.Ed. 579 (1819).

The tax immunity enjoyed by state and federal employees met its virtual demise in the late 1930's with decisions in Helvering v. Gerhardt, 304 U.S. 405, 58 S.Ct. 969, 82 L.Ed. 1427 (1938), and Graves v. New York ex rel. O'Keefe, 306 U.S. 466, 59 S.Ct. 595, 83 L.Ed. 927 (1939). Helvering held that the United States could impose a tax on the salaries of state employees, and Graves held that states could impose a tax on the incomes of federal employees.

Most of the legislative process which resulted in the passage of the Public Salary Tax Act took place after Helvering, but before Graves. According to Justice Kennedy, Congress was uncertain just what immunity might still have been available to federal employees from state taxation of their income. 4 U.S.C. § 111 was enacted to expressly waive, on behalf of the...