Kerr v. Killian

• Court: Arizona Court of Appeals
• Writing for the Court: PATTERSON.
• Citation: Kerr v. Killian, 201 Ariz. 125, 32 P.3d 408 (Ariz. App. 2001)
• Decision Date: 28 August 2001
• Docket Number: No. 1 CA-TX 00-0023.,1 CA-TX 00-0023.
• Parties: Clark R. KERR and Billie Sue Kerr, husband and wife, Susan Moran, Steve Allen and John Udall, individually and as representatives of the class comprised of federal employees who paid Arizona income taxes on federal retirement contributions during one or more of the years 1984 to date, Plaintiffs-Appellees, Cross-Appellants, v. Mark J. KILLIAN, in his capacity as Director of the Arizona Department of Revenue, the Arizona Department of Revenue of the State of Arizona, Defendants-Appellants, Cross-Appellees. State of Arizona, ex rel., the Arizona Department of Revenue, Plaintiff-Appellant, Cross-Appellee, v. Clark J. Kerr and Billie Sue Kerr, husband and wife, Defendants-Appellees, Cross-Appellants. Clark J. Kerr and Billie Sue Kerr, husband and wife; and their Attorneys, Bonn, Luscher, Padden & Wilkins, Chartered and O'Neil, Cannon & Hollman, S.C., Counterclaimants-Appellees, Cross-Appellants, v. State of Arizona, ex rel., the Arizona Department of Revenue, Counterdefendant-Appellant, Cross-Appellee.

32 P.3d 408

201 Ariz. 125

Clark R. KERR and Billie Sue Kerr, husband and wife, Susan Moran, Steve Allen and John Udall, individually and as representatives of the class comprised of federal employees who paid Arizona income taxes on federal retirement contributions during one or more of the years 1984 to date, Plaintiffs-Appellees, Cross-Appellants, v. Mark J. KILLIAN, in his capacity as Director of the Arizona Department of Revenue, the Arizona Department of Revenue of the State of Arizona, Defendants-Appellants, Cross-Appellees.

State of Arizona, ex rel., the Arizona Department of Revenue, Plaintiff-Appellant, Cross-Appellee, v. Clark J. Kerr and Billie Sue Kerr, husband and wife, Defendants-Appellees, Cross-Appellants.

Clark J. Kerr and Billie Sue Kerr, husband and wife; and their Attorneys, Bonn, Luscher, Padden & Wilkins, Chartered and O'Neil, Cannon & Hollman, S.C., Counterclaimants-Appellees, Cross-Appellants, v. State of Arizona, ex rel., the Arizona Department of Revenue, Counterdefendant-Appellant, Cross-Appellee.

No. -0023.

Court of Appeals of Arizona, Division 1, Department T.

August 28, 2001.

Bonn & Wilkins Chartered, by Paul V. Bonn, Randall D. Wilkins, D. Michael Hall, Phoenix, and O'Neil, Cannon & Hollman, S.C., by Eugene O. Duffy, Milwaukee, WI, Attorneys for Appellees-Cross-Appellants.

Janet Napolitano, Attorney General, by Patrick Irvine, Assistant Attorney General, Christine Cassetta, Assistant Attorney General, Phoenix, Attorneys for Appellant-Cross-Appellee.

OPINION

PATTERSON, Judge.

¶ 1 Under Arizona Revised Statutes (A.R.S.) § 43-1001(2) (1998 and Supp.2000), the Arizona gross incomes of state and local employees, like those of federal employees and all other Arizona individual income taxpayers, are deemed to be the same amounts that are calculated as their adjusted gross incomes for the purpose of federal income taxation. As permitted by 26 U.S.C. § 414(h)(2), Arizona has elected to "pick up" most state and local governmental employees' mandatory contributions to their retirement plans. Those contributions are therefore excluded from their federal adjusted gross (Arizona gross) incomes. A.R.S. § 43-1001(2). Congress, however, has not authorized the United States Government to "pick up" federal employees' mandatory contributions to their retirement plans. The effect of A.R.S. § 43-1001(2) on federal employees who reside in Arizona is to sweep all such contributions into their Arizona gross incomes.

¶ 2 Thus, for tax years from 1991 onward, Arizona law subjects to Arizona individual income taxation those portions of federal employees' compensation that they are required to contribute toward federal employee retirement plans, while leaving untaxed the corresponding mandatory contributions of most state employees to state employee retirement plans. This results in similarly situated and similarly earning taxpayers paying differing amounts. The superior court held that this statute, A.R.S. § 43-1001(2), violated the Public Salary Tax Act of 1939, 4 U.S.C. § 111.¹ The Arizona Department of Revenue and its director, Mark J. Killian (ADOR), appeal.

¶ 3 Plaintiffs Clark R. Kerr and Billie Sue Kerr, together with Plaintiffs Susan Moran, Steve Allen, and John Udall (the plaintiff taxpayers), cross-appeal from the superior court's orders denying certification of a plaintiff class consisting of all current or former federal employees who paid Arizona income taxes on mandatory contributions to federal retirement plans during one or more years from 1985 to the present, and of an alternative, smaller class consisting of all such federal employees who also filed timely refund claims with ADOR for one or more of the years 1991 to the present. The appeal and cross-appeal present these issues:

1. Whether Arizona's income taxing scheme violates 4 U.S.C. § 111 by taxing federal employees' mandatory contributions to retirement plans, but not those of state employees;

2. Whether the superior court erred or abused its discretion in denying the plaintiffs' motions for class certification; and

3. Whether equal protection principles preclude ADOR from demanding compliance with an administrative claim requirement for taxpayers who initially paid the challenged taxes, while at the same time declining to pursue tax enforcement against other taxpayers who subtracted their mandatory federal retirement contributions on their Arizona returns and hence did not pay the challenged taxes.²

FACTS AND RELEVANT PROCEDURE

¶ 4 Until former A.R.S. § 43-1022(2) was amended in 1989, 1989 Ariz. Sess. Laws. Ch. 312, § 12, that statute subtracted from Arizona gross income:

Contributions made to the state retirement system, the corrections officer retirement plan, the public safety personnel retirement system, the elected officials' retirement plan or a county or city retirement plan.³

Arizona law provided no corresponding subtraction for contributions made to federal employee retirement plans.

¶ 5 Since 1979, A.R.S. § 43-1001(2) has defined a resident individual's "Arizona gross income" as his or her federal adjusted gross income for the taxable year, computed under the Internal Revenue Code. See 1978 Ariz. Sess. Laws Ch. 213, § 2, eff. Jan. 1, 1979. Federal adjusted gross income is thus the starting point for determining an individual taxpayer's Arizona taxable income and ultimate income tax liability.

¶ 6 Effective in 1985, Arizona enacted provisions authorized by 26 U.S.C. § 414(h)⁴ that permitted state and local governmental employers to "pick up" mandatory contributions that their employees would otherwise have made. This enabled those state employees to exclude the amounts of their retirement plan contributions from their federal gross income. Congress has not chosen to make this benefit available to federal employees.

¶ 7 Consequently, under A.R.S. § 43-1001(2), the Arizona gross incomes of federal employees include all sums they are required to contribute to their respective retirement plans, while the Arizona gross incomes of state and local employees whose employing units "pick up" their required contributions to retirement plans necessarily exclude the amount of those contributions.⁵ See Kerr v. Waddell, 183 Ariz. 1, 12-13, 899 P.2d 162, 173-74 (App.1994) (Kerr I), vacated on other grounds, 185 Ariz. 457, 916 P.2d 1173 (App. 1996) (Kerr II)).

¶ 8 In Davis v. Michigan Department of Treasury, 489 U.S. 803, 816, 109 S.Ct. 1500, 103 L.Ed.2d 891 (1989), the Supreme Court invalidated certain Michigan income taxing provisions that taxed retirement benefits paid by the United States Government while exempting retirement benefits paid by state and local governmental entities. The Court determined that the Michigan taxing scheme violated 4 U.S.C. § 111. The Court later held that Davis was to be applied retroactively. Harper v. Virginia Dep't of Taxation, 509 U.S. 86, 113 S.Ct. 2510, 125 L.Ed.2d 74 (1993).

¶ 9 In 1989, the plaintiff taxpayers brought an earlier action, Tax Court Cause No. 89-01153, challenging the differential taxation of A.R.S. § 43-1001(2) and former A.R.S. § 43-1022(2). In Kerr I this court held that their state-law claims for refunds were barred by their failure to exhaust their administrative remedies before bringing the action, but that their claims for declaratory and injunctive relief under 42 U.S.C. § 1984 could proceed. Kerr I held that former sections 43-1022(2) and 43-1001(2), as applied to state and federal employees, violated 4 U.S.C. § 111. 183 Ariz. at 14-17, 899 P.2d at 175-78.

¶ 10 On petition for review our supreme court remanded for further consideration in light of National Private Truck Council, Inc. v. Oklahoma Tax Commission, 515 U.S. 582, 115 S.Ct. 2351, 132 L.Ed.2d 509 (1995). On remand this court held that Arizona's administrative process for challenging the denial of tax refunds provided an adequate state remedy within National Private Truck Council, and that the plaintiffs' claims under 42 U.S.C. § 1984 were barred because plaintiffs failed to resort to and exhaust those remedies. Kerr II, 185 Ariz. at 464-67, 916 P.2d at 1180-83. We remanded the action to the tax court with directions to dismiss it in its entirety. Id.

¶ 11 Simultaneously with the filing of their 1989 action in the tax court, the plaintiff taxpayers filed corresponding administrative refund claims with ADOR. In 1993, a hearing officer for ADOR determined that ADOR had no authority to rule on the legality of A.R.S. § 43-1001(2) and former A.R.S. § 43-1022(2) or to recognize a class refund claim. Kerr v. Killian, 197 Ariz. 213, 3 P.3d 1133 (App.2000) (Kerr III). In 1994, during the pendency of Kerr I in this court, the Arizona Board of Tax Appeals heard the plaintiff taxpayers' administrative appeal from the ADOR hearing officer's adverse ruling. The matter remained under advisement with the Board until 1997, the year following the dismissal of the plaintiff taxpayers' first action pursuant to Kerr II. Kerr III, 197 Ariz. at 215-16,3 P.3d at 1135-36. The Board ruled that the plaintiff taxpayers were entitled to refunds for 1985 through 1990 because former A.R.S. § 1022(2) violated the intergovernmental tax immunity doctrine codified in 4 U.S.C. § 111. The Board also held that A.R.S. § 43-1001(2) did not violate that doctrine and that no refunds for tax years after 1990 would be awarded. The Board also agreed with the ADOR hearing officer that neither ADOR nor the Board could entertain a class refund claim.

¶ 12 The plaintiff taxpayers and ADOR commenced the instant actions in April and May 1997 to appeal the Board's ruling. In mid-1997, the Governor of Arizona directed ADOR "to make refunds for the tax years 1985 through 1990 to all taxpayers who had filed timely refund claims, whether they were parties to the administrative action or not." Kerr III, 197 Ariz. at 216, 3 P.3d at 1136. In June 1998 the tax court entered a judgment awarding the plaintiffs' attorneys an award of 20% of each such...