State Law Providing Exempton from State Taxation of State But Not Federal Law Enforcement Pensions Held to Illegally Discriminate Against Federal Employees

The U.S. Supreme Court found to be illegal a West Virginia state tax break that provided an exemption from state tax for retired state law enforcement employees but did not offer the same benefit to retired federal law enforcement employees.  The Court unanimously ruled in the case of Dawson v. Steager, Case No. 17-419 that the West Virginia court was in error finding that the law was acceptable since it applied only to a narrow class of retirees and did not intend to discriminate against federal marshals.

Prior to the Court’s decision in Davis v. Michigan Dept. of Treasury, 489 U.S. 803, 810 (1989) many states had statutes that exempted retirement pay of state retirees from state tax, but did not provide such an exemption to federal retirees.  However, the Court found that such laws violated 4 USC §111(a) which provides:

(a) General Rule.—

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.

The Supreme ruled such broad laws violated the anti-discrimination provision of 4 USC §111(a) even though it discriminated against former rather than current employees.

Justice Gorsuch, writing for the Court, provided the following analysis of the anti-discrimination rule:

Section 111 codifies a legal doctrine almost as old as the Nation. In McCulloch v. Maryland, 4 Wheat. 316 (1819), this Court invoked the Constitution's Supremacy Clause to invalidate Maryland's effort to levy a tax on the Bank of the United States. Chief Justice Marshall explained that “the power to tax involves the power to destroy,” and he reasoned that if States could tax the Bank they could “defeat” the federal legislative policy establishing it. Id., at 431–432. For the next few decades, this Court interpreted McCulloch “to bar most taxation by one sovereign of the employees of another.” Davis v. Michigan Dept. of Treasury, 489 U.S. 803, 810 (1989). In time, though, the Court softened its stance and upheld neutral income taxes — those that treated federal and state employees with an even hand. See Helvering v. Gerhardt, 304 U.S. 405 (1938); Graves v. New York ex rel. O'Keefe, 306 U.S. 466 (1939). So eventually the intergovernmental tax immunity doctrine came to be understood to bar only discriminatory taxes. It was this understanding that Congress “consciously . . . drew upon” when adopting §111 in 1939. Davis, 489 U.S., at 813.

West Virginia justified its provision by arguing that its law applied only to a narrow class of employees, and that the duties of these individuals was substantially different from that of those employed in federal law enforcement.  James Dawson, a retired U.S. Marshall, challenged the state’s position, arguing that the law illegally discriminated against him by denying him the same tax deduction that he would have been allowed had he been a retired West Virginia law enforcement officer.

Justice Gorsuch described Mr. Dawson’s journey through West Virginia’s courts:

Mr. Dawson's own attempt to invoke §111 met with mixed success. A West Virginia trial court found it “undisputed” that “there are no significant differences between Mr. Dawson's powers and duties as a US Marshal and the powers and duties of the state and local law enforcement officers” that West Virginia exempts from income tax. App. to Pet. for Cert. 22a. In the trial court's judgment, the State's statute thus represented “precisely the type of favoritism” §111 prohibits. Id., at 23a. But the West Virginia Supreme Court of Appeals saw it differently. In reversing, the court emphasized that relatively few state employees receive the tax break denied Mr. Dawson. The court stressed, too, that the statute's “intent . . . was to give a benefit to a narrow class of state retirees,” not to harm federal retirees. Id., at 15a.

Mr. Dawson asked the Supreme Court to hear his appeal from the West Virginia Supreme Court and his request was granted.  The U.S. Supreme Court held that “the state trial court had it right” and the West Virginia Supreme Court erred in overturning that result.

The State argued that even if its law favored some state law enforcement retirees over their federal counterparts, the favored class was a very small one.  Most state retirees were in the same position as Mr. Dawson, not obtaining a subtraction from income for their retirement benefit.  The U.S. Supreme Court was not impressed with this argument:

We are unpersuaded. Section 111 disallows any state tax that discriminates against a federal officer or employee — not just those that seem to us especially cumbersome. Nor are we inclined to accept West Virginia's invitation to adorn §111 with a new and judicially manufactured qualification that cannot be found in its text. In fact, we have already refused an almost identical request. In Davis, we rejected Michigan's suggestion that a discriminatory state income tax should be allowed to stand so long as it treats federal employees or retirees the same as “the vast majority of voters in the State.” 489 U.S., at 815, n. 4. We rejected, too, any suggestion that a discriminatory tax is permissible so long as it “does not interfere with the Federal Government's ability to perform its governmental functions.” Id., at 814. In fact, as long ago as McCulloch, Chief Justice Marshall warned against enmeshing courts in the “perplexing” business, “so unfit for the judicial department,” of attempting to delineate “what degree of taxation is the legitimate use, and what degree may amount to the abuse of power.” 4 Wheat., at 430.

The Court noted that it would permissible for the state to exempt a narrow class of state employees if, at the same time, it offers the exemption to similarly situated federal employees.  But the mere fact that a law discriminates against only a small number of individuals under 4 USC §111 does not render that law acceptable.  Rather, the law must eliminate that discrimination.

The lack of an intent to “punish” federal retirees also cannot save the provision.  As the opinion continues:

We can safely assume that discriminatory laws like West Virginia's are almost always enacted with the purpose of benefiting state employees rather than harming their federal counterparts. Yet that wasn't enough to save the state statutes in Davis, Barker, or Phillips, and it can't be enough here. Under §111 what matters isn't the intent lurking behind the law but whether the letter of the law “treat[s] those who deal with” the federal government “as well as it treats those with whom [the State] deals itself.” Phillips Chemical Co., 361 U.S., at 385.

The state argued that there was a significant enough difference between the federal law enforcement retirees and those state retirees granted West Virginia’s exemption to justify the different treatment.  But the Court found that was not the case, noting:

The state statute singles out for preferential treatment retirement plans associated with West Virginia police, firefighters, and deputy sheriffs. See W. Va. Code Ann. §11–21–12(c)(6) (Lexis 2017). The distinguishing characteristic of these plans is the nature of the jobs previously held by retirees who may participate in them; thus, a similarly situated federal retiree is someone who had similar job responsibilities to a state police officer, firefighter, or deputy sheriff. The state trial court correctly focused on this point of comparison and found no “significant differences” between Mr. Dawson's former job responsibilities as a U.S. Marshal and those of the state law enforcement retirees who qualify for the tax exemption. App. to Pet. for Cert. 22a. Nor did the West Virginia Supreme Court of Appeals upset this factual finding. So looking to how the State has chosen to define its favored class only seems to confirm that it has treated similarly situated persons differently because of the source of their compensation.

The state argued that it could show there existed groups of state employees that were denied the exemption who were similarly situated to the federal law enforcement retirees.  But the Supreme Court found that this issue wasn’t relevant, stating:

Under §111, the relevant question isn't whether federal retirees are similarly situated to state retirees who don't receive a tax benefit; the relevant question is whether they are similarly situated to those who do. So, for example, in Phillips we compared the class of federal lessees with the favored class of state lessees, even though the State urged us to focus instead on the disfavored class of private lessees. 361 U.S., at 381–382. In Davis, we likewise rejected the State's effort to compare the class of federal retirees with state residents who did not benefit from the tax exemption rather than those who did. See 489 U.S., at 815, n. 4.

The fact that the state’s pensions were less generous than the federal pensions also did not justify this treatment.  The opinion objects that the law does not impose a specific economic test for qualification:

The problem here is fundamental. While the State was free to draw whatever classifications it wished, the statute it enacted does not classify persons or groups based on the relative generosity of their pension benefits. Instead, it extends a special tax benefit to retirees who served as West Virginia police officers, firefighters, or deputy sheriffs — and it categorically denies that same benefit to retirees who served in similar federal law enforcement positions. Even if Mr. Dawson's pension turned out to be identical to a state law enforcement officer's pension, the law as written would deny him a tax exemption. West Virginia's law thus discriminates “because of the source of . . . compensation or pay” in violation of §111. Whether the unlawful classification found in the text of a statute might serve as some sort of proxy for a lawful classification hidden behind it is neither here nor there. No more than a beneficent legislative intent, an implicit but lawful distinction cannot save an express and unlawful one.