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State taxation of federal civilian and military retirees.

In 1989 the U.S. Supreme Court ruled that states may not discriminate against Federal retirees by taxing Federal retirement income differently than the retirement income of state employers (Davis v. Michigan Department of the Treasury 489 U.S. 803). Any state taxing scheme that imposed income taxes on Federal retirement benefits while exempting state retirement benefits was declared unconstitutional. About 21 states were involved in the unconstitutional taxation of Federal retirement benefits.

While the U.S. Supreme Court's Davis decision was fine for taxation in years subsequent to 1989--during which the state legislatures modified their income tax laws to come into compliance with the decision--the big question was whether the discriminatory tax laws against Federal retirees' benefits applied retroactively: could the affected taxpayers claim refunds on the taxes paid prior to the 1989 Davis decision? Several states immediately held that retroactivity applied and ordered a refund of the illegally-collected taxes for years open under the statute prior to the Davis decision.

However, most of the states ruled that the Federal retirees were not entitled to recovery of taxes paid in prior years because the Davis decision did not apply retroactively. Federal retirees in those states were thus entitled to future relief but could not recover past taxes paid under the discriminatory tax laws.

In an action brought by a group of Federal retirees in Virginia, the U.S. Supreme Court recently held that the 1989 Davis decision should be applied retroactively, but the Court's decision stopped short of ordering a refund of taxes paid prior to Davis. (Harper v. Virginia Department of Taxation, U.S. Supreme Court, No 91-794 decided June 17, 1993). Justice Thomas, writing the opinion for the U.S. Supreme Court, said "...Federal law does not necessarily entitle them [the Federal retirees] to a refund." While the Federal retirees supporting the Harper case were obviously disappointed that the Supreme Court did not order a refund, they received half a loaf in that the Court did clearly hold that the Davis decision applied retroactively. The court left open the possibility that the states may provide a credit to Federal retirees against future taxes rather than providing a refund for taxes already paid.
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Author:Sager, William H.
Publication:The National Public Accountant
Date:Oct 1, 1993
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