So you think a state cannot change its tax laws after the fact to validate an erroneous legal interpretation by its revenue department that caused massive over-reporting of tax? Think again. Indeed, we were reminded earlier this week that, at least in some circumstances, states can retroactively adjust the rules to foreclose even pending claims for tax relief.
The United States Supreme Court on May 24 declined to review a decision by the Kentucky Supreme Court in Miller v. Johnson Controls, Inc., 296 S.W.3d 392 (Ky. 2009). In Miller, the Kentucky Court upheld a state statute enacted in 2000 that retroactively barred refund claims by a group of corporate taxpayers who complied with a policy adopted by the Kentucky Revenue Cabinet, challenged the policy as unlawful, and got it invalidated back in 1994 (by the Kentucky Supreme Court, no less).
Here’s the background: In 1988, the Revenue Cabinet interpreted Kentucky law as prohibiting the filing of unitary income tax returns by corporate taxpayers, and instead required each corporation to file a separate return. The inability to file unitary returns resulted in substantially higher Kentucky taxes for a number of corporations. After the Kentucky Supreme Court ruled in 1994 that unitary returns were allowed under Kentucky law, the taxpayers amended their earlier returns, and sought refunds for the excess tax paid during the earlier years.
In 1996, the Kentucky legislature formally abolished the filing of unitary returns for tax years after 1994. Then, in 2000, with the pending refund claims for earlier years creating the prospect of a massive drain on the state treasury, the legislature passed a law prohibiting the filing of refund claims for any tax year before 1995, based on the submission of an amended, unitary return filed after December 22, 1994. As a result, even those taxpayers who had successfully challenged the 1988 policy in court and had pending refund claims were retroactively precluded from obtaining refunds of excess tax paid.
In response to a challenge to the retroactive effect of the 2000 statute, the Kentucky Supreme Court, citing United States v. Carlton, 512 U.S. 26 (1994), held last year that the law satisfied the requirements of due process because it was rationally related to the legitimate governmental purpose of raising and controlling revenue. The Court found that the taxpayers could have no settled expectation of obtaining the refunds, given the legislature’s action in 1996 to reverse the effect of the Court’s 1994 decision for subsequent years. The Court further held that the new, retroactive tax statute infringed no fundamental constitutional right of the taxpayers and thus resulted in no violation of equal protection.
The taxpayers asked the United States Supreme Court to review the decision, but the Court on Monday turned down the request. Johnson Controls v. Miller, U.S. Supreme Court, Dkt 09-981, petition for cert. denied (May 24, 2010). In light of the existing jurisprudence on taxpayer due process embodied by Carlton, the Kentucky case perhaps breaks no new constitutional ground, but it may expand the limits (not yet fully defined) on how far a state may go to foreclose tax relief in order to protect state coffers.