Does a West Virginia law that provides a state tax benefit to certain retired state and local law-enforcement officers, but not to retired U.S. Marshals, unlawfully discriminate against federal retirees in violation of the doctrine of intergovernmental tax immunity, as codified by 4 U.S.C. § 111?
This case asks the Supreme Court to examine § 11-21-12(c)(6) of the West Virginia Code (“§ 12(c)(6)”), which grants an income tax exemption for the retirement compensation of state retirees, but not of federal retirees. Petitioner James Dawson contends that § 12(c)(6) violates federal law 4 U.S.C. § 111 (“§ 111”), which prohibits discriminatory tax treatment against federal employees by state governments. Under the Supreme Court’s Davis test, according to Dawson, a state law violates § 111 by imposing higher taxes on income from the federal government than income from the state government when there are no significant differences between the two to justify the heavier tax burden placed on federal income. Respondent Dale Steager, the State Tax Commissioner of West Virginia, counters that § 12(c)(6) does not discriminate against federal retirees because § 12(c)(6) applies in very narrow cases. Steager further argues that West Virginia treats federal employees the same as state employees, and Dawson is not similarly situated to state retirees that are eligible for this tax exemption. The outcome of this case will affect state-level taxing policy and tax exemptions afforded only to state employees.
Questions as Framed for the Court by the Parties
Whether the doctrine of intergovernmental tax immunity, as codified in 4 U.S.C. § 111, prohibits the State of West Virginia from exempting from state taxation the retirement benefits of certain former state law-enforcement officers, without providing the same exemption for the retirement benefits of former employees of the United States Marshals Service.
Petitioner, James Dawson, retired from his position as a U.S. Marshal on March 31, 2008. Steager v. Dawson at 2. Dawson currently receives retirement income from the Federal Employee Retirement System (“FERS”). Id.
The State of West Virginia taxes retirement income received by the majority of local and state retirees living in West Virginia. Steager v. Dawson at 1. West Virginia also taxes retirement income received by federal retirees from any federal source, including the military. Id. at 2. West Virginia’s tax code, however, provides for a number of exemptions from taxation for income received from a government pension. Id. One such exemption from state income tax, written in West Virginia Code § 11-21-12(c)(6) (“§ 12(c)(6)”), exempts all retirement benefits from four specifically enumerated plans that benefit state and local police officers, firefighters and sheriffs. Id. By contrast, West Virginia law exempts from taxation only up to $2,000 of retirement benefits received under the West Virginia Public Employees Retirement System (“PERS”), the State Teachers Retirement System (“TRS”), or general federal retirement plans. Id. at 1–2. According to federal law 4 U.S.C. § 111, states may only tax income given by the federal government to federal employees “if the taxation does not discriminate against the officer or employee because of the source [of the income].” Id. at 5.
Dawson and his wife filed amended tax returns for the 2010 and 2011 tax years, claiming exemption under § 12(c)(6) for income received from FERS, despite FERS’ lack of inclusion in § 12(c)(6). Id. at 3. After Respondent, West Virginia’s Tax Commissioner Dale Steager, denied this exemption, Dawson appealed to the Office of Tax Appeals. Id. On appeal, Dawson argued that § 12(c)(6) discriminates against federal law-enforcement officers by not granting income exemptions equally to retired state, local, and federal law-enforcement officers. Id. Steager countered that § 12(c)(6) does not intentionally discriminate against federal employees and applies to only a small category of state and local retired employees. Id. The Office of Tax Appeals held for Steager. Id.
Dawson then appealed to the Circuit Court of Mercer County, which held on March 31, 2016 that § 12(c)(6) intentionally violates the anti-discrimination provision of 4 U.S.C. § 111. Id. Steager then appealed to the State of West Virginia Supreme Court of Appeals. Id.
Before the West Virginia Supreme Court of Appeals, Steager argued that there is no recorded evidence that § 12(c)(6) was created to intentionally discriminate against retired federal employees. Id. at 4. Considering the totality of West Virginia’s tax code, the West Virginia Supreme Court of Appeals sided with Steager. Id. In its opinion, the court discussed the concept of intergovernmental tax immunity, which immunizes federal government employees from discriminatory taxation by a state. Id. The court cited to Davis v. Michigan Dept. of Treasury for the proposition that if there is a substantial difference between federal and state employees to justify taxing them differently, then 4 U.S.C. § 111 has not been violated. Id. at 6. The court then noted that the tax exemptions apply only to a certain percentage of state and local law enforcement officers. Id. at 7. Further underscoring § 12(c)(6)’s narrowness, the court noted that the exemptions apply to firefighters but not to paramedics or emergency medical technicians. Id. at 7–8. Thus, considering the totality of the circumstances, the court held that the § 12(c)(6) exemptions are not discriminatory because they apply only to a narrow category of state and local retirees, and Dawson received the same, if not a more favorable, state income tax treatment as certain state employees. Id. at 8.
THE MEANING AND PURPOSE OF § 111
Dawson states that § 111(a) prohibits a state from imposing a tax that discriminates against federal employees “because of the source of pay.” Brief for Petitioners, James Dawson and Elaine Dawson at 4, 12. Dawson argues that the Court in Davis v. Michigan Department of Treasury adopted a bright-line rule to determine whether a state violates § 111. Id. at 16. Under this bright-line rule, according to Dawson, a state violates § 111 when it imposes a higher tax burden on the income of federal employees than the income of state employees, and “significant differences” between the federal and state employees do not support discriminatory tax treatment. Id. at 12. Dawson further maintains that the Davis Court rejected a totality-of-the-circumstances test that would consider the number of state employees receiving favorable tax treatment in determining whether a state tax scheme that taxes federal employees more than state employees is discriminatory. Id. at 15–16.
In contrast, Steager argues that the doctrine of intergovernmental tax immunity aims to prevent the taxing authority of one sovereign from interfering with the governmental functions of another. Brief of Respondent, Dale W. Steager, State Tax Commissioner of West Virginia at 21–22. Steager thus emphasizes that § 111 forbids only state tax distinctions between federal and state employees that discriminate against federal employees “because of the source of the pay or compensation.” Id. at 19. Steager agrees with Dawson that a state tax provision violates § 111 if the provision discriminates against federal employees, and there are no significant differences between federal and state employees to justify the discrimination, but asserts that the statute prohibits only those distinctions based on “the name at the bottom of a public retiree’s benefits check.” Id.
THE APPLICATION OF THE DAVIS TEST
According to Dawson, the Supreme Court has always applied the bright-line test articulated in Davis rather than a totality-of-the-circumstances test. Brief for Petitioners at 18–19. Dawson states that if a state tax provision fails the Davis test, then the provision discriminates against federal employees in violation of § 111. Id. at 19. In applying the bright-line Davis test, Dawson argues that § 12(c)(6) discriminates against federal employees in violation of § 111. Id. First, Dawson contends that West Virginia taxes him and other federal law-enforcement retirees higher than state law-enforcement retirees, as § 12(c)(6) allows most state law-enforcement retirees to exempt all their retirement benefits from tax, but only allows federal law-enforcement retirees like him to exempt the first $2,000 retirement benefits they receive. Id. Second, Dawson posits that there are no “significant differences” between federal and state law-enforcement retirees to justify the higher tax burden placed on federal retirees. Id. at 20. Specifically, Dawson notes that the duties of a U.S. Marshal are no different than the duties of State and local law-enforcement officers. Id. Thus, after applying the Davis test, Dawson asserts that § 12(c)(6) violates § 111 because to receive the full tax exemption under West Virginia law, a retiree must receive retirement benefits from a state retirement plan, not from the federal government. Id.
Steager argues that West Virginia’s Supreme Court of Appeals’ totality-of-the-circumstances test conforms with Davis because Davis involved a state tax provision that undisputedly discriminated against federal retirees in favor of state retirees, and did not hold that a state tax provision is discriminatory whenever “any state retirees [are] treated better than federal retirees.” Brief for Respondent at 24–26. Applying either approach to the Davis test, Steager contends that § 12(c)(6) does not discriminate against federal employees. Id. at 27. First, according to Steager, § 12(c)(6) does not interfere with the functions of the federal government because the tax exemption applies only to 2 percent of state employees. Id. As such, Steager maintains that a tax regime violates intergovernmental tax immunity when the regime discriminates against a large number of federal employees so as to interfere with federal governmental functions, which is not the case here due to the small number of state employees eligible for the full exemption. Id. Second, Steager asserts that the political process provides adequate oversight to prevent discrimination. Id. at 32. Specifically, Steager contends that West Virginia treats federal retirees the same as all but 2 percent of state retirees eligible for the § 12(c)(6) exemption, meaning the interests of all private sector retirees, all federal retirees, and over 98 percent of state retirees are aligned. Id. at 35. Also, Steager notes that West Virginia implemented several policies that exclusively benefit federal retirees such as exemptions for federal military retirement income. Id. at 35–36. Finally, Steager suggests that an expansive view of § 111 would break from historical precedent. See id. at 36–37. For the second step of the Davis test, Steager posits that there are significant differences between state and federal retirees to justify this disparate treatment based on state retirees contributing more into the state retirement plan than federal retirees contribute into the federal retirement plan. Id. at 51–52, 56.
THE SCOPE OF THE DAVIS TEST
Dawson contends that the state court erroneously upheld § 12(c)(6) on grounds that the Davis Court rejected and instead relied upon state precedent, Brown v. Mierke. Brief for Petitioners at 21. First, Dawson maintains that, in following Brown, the state court incorrectly held that Davis applies only when a state provides favorable tax treatment to all—not just some—state retirees. Id. at 21–22. Second, Dawson argues that the state court erroneously determined that a state violates § 111 when the state intends to discriminate against federal retirees or provide benefits only available to state retirees. Id. at 21. Here, Dawson asserts that state intent is irrelevant because the state could simply avoid liability by providing some benefit to a small number of state retirees without actively discriminating against federal retirees. Id. at 27. Lastly, Dawson posits that the state court’s focus on the fact that West Virginia treated federal employees better than private-sector employees is misplaced because, according to Dawson, a state’s treatment of private-sector employees is irrelevant in determining whether a provision violates § 111. Id. at 21. Dawson points out that the Davis court established that courts should not consider private sector employees in the § 111 analysis because the relevant inquiry focuses on whether a state imposes discriminatory tax treatment against federal retirees—not private-sector employees—and private-sector employees do not receive retirement benefits from state or federal plans. Id. at 29. In this regard, the Davis test, Dawson asserts, provides a clear bright-line rule in comparison to the state court’s totality-of-the-circumstances test that involves whether there is intent to discriminate against federal retirees. Id. at 30–31. As such, Dawson plainly states that the state court framework is unworkable, and that the correct standard is the Davis bright-line test. See id. at 31.
In contrast, Steager argues that to prove § 12(c)(6) violates § 111 under the Davis test, Dawson must demonstrate that West Virginia’s tax regime treated him differently than “similarly situated” state retirees. Brief for Respondent at 38. Section 12(c)(6), Steager contends, applies to a narrow set of state employees, which Dawson does not fall within. Id. at 39. Moreover, Steager asserts that a tax scheme that treats “similarly situated” federal and state employees the same is not discriminatory under § 111. Id. Steager notes that satisfying a “similarly situated” test is difficult. Id. First, Steager posits that unless a challenged statute defines a class arbitrarily or in a way that is “invidiously discriminatory,” in identifying similarly situated taxpayers, the court should focus on the classification stated in the statute itself. Id. at 39–40. Second, according to Steager, the fact that federal employees may never qualify to receive a state tax exemption does not change this rule. Id. at 41. As long as the statutory provision is facially neutral, the statutory provision does not discriminate even when it places a heavier burden on federal employees, contends Steager. Id. Third, Steager states that to show § 12(c)(6) is unlawfully discriminatory, Dawson must show that West Virginia treated him differently than the most similar state employees. Id. at 41–42. Accordingly, Steager asserts that Dawson was treated the same as similarly situated state retirees, and thus § 12(c)(6) does not discriminate against federal retirees. Id. at 43–45. Steager points out that Dawson did not receive any retirement benefits from one of the exempt State-managed plans and was therefore similarly situated to many other state retirees, who did not receive retirement benefits from the exempt plans. Id. at 45. Also, Steager disagrees with Dawson’s assertion that job duties are relevant to the § 111 analysis. Id. at 47. According to Steager, job description is not a factor to determine whether state and federal employees are similarly situated because § 12(c)(6) does not focus on retirees’ former job duties, but the type of plan in which they are enrolled. Id
POTENTIAL ECONOMIC CONSEQUENCES FOR RETIRED FEDERAL EMPLOYEES NATIONWIDE
National Active and Retired Federal Employees Association, (“NARFE”), in support of Dawson, argues that if the Court decides to allow states to tax state government retirees more favorably than federal government retirees with substantially similar job positions, the decision would negatively impact all federal retirees nationwide—approximately 2.6 million people. See Brief of Amicus Curiae NARFE, in Support of Petitioner at 3. According to NARFE, the negative economic impact on federal retirees makes West Virginia’s tax scheme illegal, regardless of state legislative intent. Id. NARFE posits that a ruling against Dawson in this case would result in reduced protections for federal retirees as state legislatures across the country could potentially change their tax codes in ways that would negatively impact federal retirees. Id. at 3–4. State legislatures, NARFE asserts, have held back on taxing federal retiree benefits more harshly than state and local retiree benefits precisely because they felt unable to in light of the Supreme Court’s decision in Davis. Id. at 4. Moreover, NARFE maintains that states have an economic incentive to avoid following § 111. Id. at 5. State legislatures, including in West Virginia, NARFE contends, have been able to shirk § 111 by providing tax breaks for narrow categories of state and local government retirees. Id. NARFE argues that state legislatures will increase taxes levied upon federal retirees if the Court if decides in this case to narrow current anti-discrimination provisions that protect federal retirees. Id. at 8. Federal retirees are particularly in need of protection from discriminatory taxes, NARFE notes, given that federal retirement benefits are typically small and subject to reductions. Id. at 6. NARFE contends that increasing taxes against federal retirees to the benefit of state and local employees would be a particularly unfair result given that state and local retiree benefits are typically higher than federal retiree benefits. Id. at 8. Additionally, also in support of Dawson, the Department of Justice asserts that a state’s desire to foster its own state and local employees’ interests does not justify discriminatory tax treatment against federal retirees, even if such tax treatment was not created to intentionally discriminate against federal retirees or the federal government. See Brief of Amicus Curiae The United States, in Support of Petitioner at 25.
In contrast, Steager contends that the § 12(c)(6) tax exemption at issue applies to only a narrow category of retirees and does not provide a blanket exemption for all state and local law-enforcement retirees. Brief of Respondent, Dale W. Steager, State Tax Commissioner of West Virginia at 11. Instead, Steager argues that § 12(c)(6) exemptions mechanically apply to certain retirement plans rather than discriminatorily apply to certain job categories. Id. at 48. For example, Steager states that not all state and local sheriffs and police officers receive the full tax exemption under § 12(c)(6) because many of these employees draw benefits from PERS, which is a retirement plan that does not receive full tax exemption under § 12(c)(6). Id. at 10–11. In support of this assertion, Steager notes that PERS is the default retirement plan for deputy sheriffs in West Virginia. Id. at 11. Thus, Steager emphasizes that under West Virginia law, federal retirees like Dawson receive the same tax treatment as some state law-enforcement retirees. Id. at 48 – 49. Additionally, Steager points out that the state and local government retirees that benefit from § 12(c)(6) also contributed a higher percentage of their salaries to their retirement plans while they were active employees than the federal retirees. Id. at 10. In direct contradiction to NARFE’s claim that federal retirees need particular protection from discriminatory state taxes, Steager implies that § 12(c)(6) remedies disparate treatment of federal and state retirees, as those receiving benefits exempt from taxation under § 12(c)(6) either cannot receive social security benefits or otherwise collect smaller retirement benefits than retired U.S. Marshals. Id. at 54. Moreover, Steager contends that since 2000, West Virginia has diminished its tax exemption for state retirees, while adding favorable tax policies for federal retirees. Id. at 35–36.
- David Ebersole and David Kall, U.S. Supreme Court to hear challenge to West Virginia Exemption of State Retirement Benefits, Business Advocate (July 5, 2018).
- Lisa Soronen, SCOTUS to Decide if Tax Breaks for State and Local Government Retirees are Unlawful, National Conference of State Legislatures (Sept. 7, 2018).