Dawson v. Steager (Decision February 20, 2019)
A former federal marshal will get the same tax benefits West Virginia gives to its retired police officers and firefighters.
James Dawson, a retired federal marshal, argued he was being unfairly taxed. West Virginia exempts the retirement income of some of its law enforcement officers (specifically, firefighters, sheriffs, and state and local police officers). But Dawson didn't qualify for this tax benefit.
Dawson argues that West Virginia can't give its state officers special benefits unless it treats federal officers at least as well. So he sued Steager, the West Virginia tax commissioner.
Dawson's argument was based on an ancient Supreme Court rule, the doctrine of intergovernmental tax immunity. The Court announced the rule in 1819, in one of the most famous cases in its history: McCulloch v. Maryland. In McCulloch, it held the state of Maryland could not tax the federal Bank of the United States.
The Court's reasoning in McCulloch relied on foundational structural features of our system of government. Under the separation of powers principle, state and federal government generally have separate and distinct areas of control. And under the federal supremacy principle, if state and federal laws clash, federal law wins.
Allowing Maryland to tax the federal bank would violate these principles, the Court said, because it would allow Maryland (or any other state) to starve the federal government of the money it needed to run itself. Therefore, the Court ruled that a state can't tax the federal government unless Congress agrees to it. Later, Congress put this rule in statutory law at 4 U.S.C. § 111, so in this case both the constitutional and statutory laws apply.
Applying the rule: Wages of federal employees
After McCulloch, the Court dealt with variations of the same issue. It later held that states couldn't tax the wages that the federal government paid to its employees — until 1939, when Congress consented to states taxing federal employee income. The statute, 4 U.S.C. § 111 (still law today), allows states to tax federal employee wages, but only if the tax "does not discriminate against the officer or employee because of the source of the pay or compensation." In other words, a state can tax federal employee wages only if they treat federal employees at least as well as they treat state employees.
Later cases: State tax benefits for subgroups of state employees
But 4 U.S.C. § 111 didn't settle the issue completely, and the question of whether states tax federal employees fairly has come up repeatedly. For example, in the 1989 case Davis v. Michigan, the Court held it violated the doctrine for Michigan to exempt the retirement income of state employees while taxing the retirement income of federal employees.
The question is more complicated when states give tax benefits to subgroups of employees. In Jefferson County v. Acker, federal judges argued Alabama had taxed them unfairly. Alabama's law exempted judges from its license tax but only if they had a specific type of license under a different Alabama law. Federal judges had no need to get that other license, so they never would qualify for the tax exemption. Effectively, the judges said, Alabama had created a state-judge-only tax exemption.
But the Court wasn't willing to go that far. It said the test for deciding whether federal employees were being unfairly taxed was whether they were "similarly situated" with the group of state employees getting the tax benefit. In Acker, not all Alabama judges got the tax exemption, so the Court held it constitutional. The Court viewed Alabama's tax exemption as a way of mitigating its duplicative licensing scheme instead of a way of singling out federal judges.
Applying the doctrine to Dawson's case
In Dawson, the Court was asked whether a state can give a tax benefit to a subgroup of state employees without giving the same benefit to similarly situated federal employees. The West Virginia trial court already had determined Dawson was "similarly situated" to the West Virginia officers, but the West Virginia Supreme Court of Appeals ruled “similarly situated” wasn’t the distinction that mattered.
The West Virginia Supreme Court of Appeals had ruled that the state was allowed to give a benefit to a small class of state workers and that the comparison to federal workers wasn’t relevant to the state’s policy decision. In the West Virginia Supreme Court’s opinion, because the benefit was intended to affect only a small number of state workers, it was not discriminatory to federal officers.
The Supreme Court ruling
The Supreme Court ruled the West Virginia Supreme Court of Appeals had it wrong. “Similarly situated” is the relevant question a court should ask when evaluating a potentially discriminatory state tax scheme. If the tax law groups people based on job responsibilities, then a court will review whether the state and federal classes with similar job responsibilities are treated the same.
Thus, the Court ruled unanimously (and with “little difficulty”) that the West Virginia tax scheme treated Dawson less favorably merely because the source of his income was the federal government. The state will have to revise its tax provisions to resolve the disparate treatment.