Title: Tarrant v. VT Department of Taxes

State: vermont

Issuer: Vermont Supreme Court

Document:

Tarrant v. Department of Taxes (96-608); 169 Vt. 189; 733 A.2d 733

[Opinion Filed 9-Apr-1999]
[Motion for Reargument Denied 3-May-1999]

       NOTICE:  This opinion is subject to motions for reargument under
  V.R.A.P. 40 as well as formal  revision before publication in the Vermont
  Reports.  Readers are requested to notify the Reporter  of Decisions,
  Vermont Supreme Court, 109 State Street, Montpelier, Vermont 05609-0801 of
  any  errors in order that corrections may be made before this opinion goes
  to press.

                                 No. 96-608

Richard and Amy Tarrant	                    Supreme Court

                                            On Appeal from
     v.		                            Washington Superior Court

Vermont Tax Department	                    September Term, 1997

John P. Meaker, J.

       Robert B. Luce, William Roger Prescott and Christopher D. Roy of
  Downs, Rachlin & Martin,  P.C., Burlington, for Plaintiffs-Appellees.

       Jeffrey L. Amestoy, Attorney General, J. Wallace Malley, Jr., Acting
  Attorney General, and John  M. Bagwell, Special Assistant Attorney General,
  Montpelier, for Defendant-Appellant.

       Stephen S. Ostrach, Boston, Massachusetts, for Amicus Curiae New
  England Legal Foundation.

PRESENT:  Johnson and Skoglund, J.J., and Allen, C.J. (Ret.), Gibson,
          J. (Ret.) and Katz, Supr. J., (Specially Assigned).

       SKOGLUND, J.  The Vermont Department of Taxes appeals a superior court
  decision  holding that taxpayers Richard and Amy Tarrant are entitled to an
  income tax credit on their 1989  joint income tax return for their pro rata
  share of taxes paid by their S corporation to states that  did not
  recognize the pass-through taxation treatment of such corporations.  The
  Department  contends the court erred by construing the newly enacted 32
  V.S.A. § 5916, which explicitly  disallows the credit at issue, as an
  amendment to 32 V.S.A. § 5825 rather than as a clarification  of
  preexisting law. We affirm.

       The parties stipulated to the facts of this case.   IDX Systems
  Corporation, formerly  known as IDX Corporation, has its headquarters in
  South Burlington, and taxpayers are Vermont 

 

  residents.  In 1989, Mr. Tarrant was president of IDX and owned 48.23% of
  its shares.(FN1)   Previously, IDX had made a valid federal S corporation
  election, also recognized by Vermont.  By virtue of this election, IDX did
  not pay either federal or Vermont corporate income taxes in  1989.  That
  is, as explained in more detail below, rather than the corporation paying
  taxes on  distributions to shareholders and the shareholders then paying
  personal taxes on the distributions  received, IDX's income, whether or not
  distributed, was attributed to its shareholders in  proportion to their
  percentage of ownership.  Thus, in 1989 taxpayers reported and paid taxes
  on  48.23% of IDX's net income -- allocable to Mr. Tarrant as a shareholder
  -- as personal income  for federal and Vermont tax purposes.  This is known
  as pass-through taxation.  See I.R.C. §  1366 (1986). 

       During the year at issue, IDX conducted business in a number of states
  beyond Vermont.  In those states that accorded IDX pass-through tax
  treatment, taxpayers were required to pay  personal income taxes on their
  pro rata share of IDX's net income attributable to IDX's business 
  activities in those states.  Since taxpayers paid personal income taxes to
  those states, they were  permitted to claim a credit pursuant to § 5825 for
  those taxes.  IDX conducted business, however,  in several other states
  (FN2) that either did not recognize IDX's S corporation status (FN3)  or, 
  while recognizing IDX as an S corporation, nonetheless imposed a state,
  corporate-level tax on  IDX's net income attributable to the corporation's
  activities within the state.(FN4)   
  

       In 1991, taxpayers timely filed an amended Vermont income tax return
  for 1989, claiming  a credit under § 5825 against their 1989 Vermont
  personal income taxes for a pro rata share of  taxes that IDX paid to such
  non-pass-through-taxation states.  Pursuant to the version of § 5825  in
  effect for 1989:

    A taxpayer of this state . . . shall receive credit against the tax 
    imposed, for that taxable year, by section 5822 of this title for taxes 
    imposed by and paid to, another state or territory of the United 
    States or the District of Columbia, upon his income earned or 
    received from sources within that state, territory, or district.
  
  32 V.S.A. § 5825 (Cum. Supp. 1989).(FN5)   The Department denied the
  credit.  Taxpayers  appealed the denial to the Commissioner of Taxes,
  maintaining that because Vermont passes S  corporation income through to
  the shareholders the tax imposed by other states on IDX's income 
  constituted a tax imposed on taxpayers' income.  The Commissioner denied
  the claim on the  grounds that § 5825 only afforded the credit where
  taxpayers were personally liable to pay the  taxes to the other state.
  Taxpayers then appealed the Commissioner's adverse determination to the 
  superior court. 

       On May 15, 1996, prior to hearing but after the parties had filed
  memoranda of law with  the superior court, the Legislature passed Act No.
  169, entitled "An Act Relating to  Miscellaneous Tax Changes."  Whereas
  Vermont's tax code had previously contained only de  minimis coverage of S
  corporation taxation, section 21 of the Act created a new taxation 
  subchapter dealing specifically with the tax treatment of S corporations. 
  See 1995, No. 169 (Adj.  Sess.), § 21; Title 32, chapter 151, subchapter
  10A.  Section 5916 of this new subchapter  provides:

    For purposes of section 5825 of this title, no credit shall be 
    available to a resident individual, estate or trust for taxes imposed 
    by another state or territory of the United States, the District of 
    Columbia or a Province of Canada upon an S corporation or the 
    income of an S corporation.

  This section applies to tax years beginning on or after January 1, 1997. 
  See 1995, No. 169 (Adj.  Sess.), § 27.  The Legislature also provided a
  sunset provision for this section; it lapses as of  January 1, 2000.  See
  id. 

       The court allowed both parties to file supplemental memoranda to
  address the  Commissioner's decision in light of this new legislation. 
  Taxpayers did not dispute that, if § 5916  had been in effect in 1989, they
  could not have received the § 5825 credit they seek.  They  argued,
  however, that § 5916 constituted an amendment, altering the meaning of §
  5825.  By  contrast, the Department contended that § 5916 only confirmed
  and restated the existing law of  § 5825.  The court, agreeing with
  taxpayers' interpretation of § 5916 and noting that this  interpretation
  was the "most significant" factor in its decision, reversed the
  Commissioner's  determination and allowed the credit.  This appeal
  followed.	

       Before addressing the specific issue on appeal, we first set forth, by
  way of background,  a brief overview of the S corporation business form. 
  "One of the disadvantages of doing business  in [traditional] corporate
  form is the phenomenon of `double taxation.'"  Wolff v. Director of 
  Revenue, 791 S.W.2d 390, 391 (Mo. 1990).  A traditional corporation, also
  known as a C  corporation because its governing provisions are found in
  Subchapter C, Chapter 1, Subtitle A of  the United States Internal Revenue
  Code (I.R.C.), is treated as a separate taxable entity by the  federal
  government and is required to pay corporate income taxes based on or
  measured by its net  income.  When a C corporation distributes its earnings
  and profits to its shareholders, these  distributions generally are taxable
  to the shareholders as dividends.  Thus, a C corporation's  income that is
  distributed to its shareholders is taxed twice:  once at the corporate
  level and once  at the personal level.

       In 1958, Congress adopted Subchapter S of the I.R.C. primarily to
  curtail the impact of 

 

  double taxation on small businesses.  See generally P. McDaniel et al.,
  Federal Income Taxation  of Partnerships and S Corporations, at 383-87 (2d
  ed. 1997) (discussing legislative history and  purpose of S corporations);
  14A W. Fletcher et al., Fletcher Cyclopedia of the Law of Private 
  Corporations §§ 6970.191-6970.215 (perm. ed. rev. vol. 1991) (discussing S
  corporation  characteristics).  Subchapter S permits small businesses, or S
  corporations, to receive the "non-tax  advantages of incorporation such as
  continuity of existence, insulation from personal liability, and  ease of
  transferability of ownership," Cohen v. Colorado Dep't of Revenue,