### Whether Missouri Municipalities May Tax the Portion of

Federal Salaries Voluntarily Contributed to the

Thrift Savings Plan

Intergovernm ental tax im m unity does not preclude m unicipalities in Missouri from levying an earnings tax on the voluntary contributions of federal em ployees to the Thrift Savings Plan.

N o v e m b e r 10, 1993

M e m o r a n d u m O p i n i o n f o r t h e G e n e r a l C o u n s e l

D e p a r t m e n t o f A g r i c u l t u r e

Y o u have requested our opinion on the following question: Must the National Finance Center (“NFC”) of the Department of Agriculture (“USDA”) withhold and remit local earnings taxes levied by the municipalities of St. Louis and KansasCity, Missouri, upon that portion o f federal employees’ salaries voluntarily contributed to the Thrift Savings Plan (“TSP”)?1 The Financial Management Service (“FMS”) of the Department of the Treasury (“Treasury”) has taken the position that NFC should not withhold the Kansas City earnings taxes on TSP contributions of FMS employees because similar payments made by municipal employees are not subject to the earnings tax.2 As we explain in further detail below, we disagreewith this approach because TSP contributions, which are held in trust for the contributors, can be distinguished from the deferred compensation plan payments that are exempt — by a court ruling — from earnings taxes. Thus, intergovernmentaltax immunity does not preclude the Missouri municipalities from levying an earnings tax on voluntary TSP contributions. The St. Louis and Kansas City earnings
taxes should be withheld and remitted.

I.

The Thrift Savings Plan, 5 U.S.C. §§ 8431-8440d, which was established as part of the Federal Employees’ Retirement System (“FERS”), 5 U.S.C. §§ 8401- 8479, enables each federal employee covered by FERS to elect to contribute, inany pay period, as much as ten percent of the employee’s “basic pay” to the employee’s TSP retirement account. 5 U.S.C. § 8432(a). All TSP contributions are

1 Letter for Daniel K offsky, Acting A ssistant A ttorney G eneral, O ffice of Legal Counsel, from Jam es S G illiland, G eneral Counsel, Department of A griculture (July 12, 1993). 2 N either FM S nor any other unit of T reasury has subm itted a brief in response to the USDA request, but the position of T reasury is set forth in a m em orandum w ritten by A ttom ey-A dvisor Elton A Ellison of theO ffice o f C hief C ounsel dated M ay I, 1990, and a letter drafted by A ssistant Com m issioner B land T. Brockenborough dated January 2, 1992

142The N eed To W ithhold and Rem it Local Earnings Taxes

channeled into a Thrift Savings Fund in the Treasury of the United States.3 Id. § 8437(b). These contributions are then held in the Fund in trust for the employees
who made the contributions. Id. § 8437(g). By law, the Thrift Savings Fund is “treated as a trust described in section 401(a) of [the Internal Revenue] Code which is exempt from taxation under section 501(a) of such Code,” id. § 8440(a)(1), and contributions to the Thrift Savings Fund are “treated in the same
manner as contributions to” such a trust. Id. § 8440(a)(2).

II.

Two cities in Missouri — St. Louis and Kansas City — have adopted ordinances that impose a tax on salaries, wages, and other compensation earned or received by city residents and nonresidents who work in the cities. Kansas City, Mo., Code 32.141(a)(1) & (2); St. Louis, Mo., Code § 5.22.020(A) & (B). Kansas City imposes “a one per centum (1 .0%) per annum” municipal tax:

(1) On all salaries, wages, commissions and other compensation earnedor received by resident individuals of the city for work done or services performed or rendered.

(2) On all salaries, wages, commissions and other compensation earned or received by nonresident individuals of the city for work done or services performed or rendered in the city.

Kansas City, Mo., Code § 32.141(a). Similarly, St. Louis imposes an earnings tax “for general revenue purposes of one percent” on all “salaries, wages, commissions and other compensation” earned by its residents and by nonresidents for “work done or services performed” in the city. St. Louis, Mo., Code § 5.22.020(A) & (B). In 1989, however, the Missouri Court of Appeals determined that the City ofKansas City could not levy its municipal earnings tax upon sums paid at the direction of an employee of the Board of Police Commissioners to the Kansas City Police Department Deferred Compensation Plan. Whipple v. City o f Kansas City, 779 S.W.2d 610 (Mo. Ct. App. 1989). The Whipple court reasoned that, because all sums paid to the Deferred Compensation Plan were exchanged for nothing more than “the unsecured promise of the board to pay the employee whatever balancemay be in the account at the employee’s retirement or separation from the department,” id. at 611, such sums were not subject to the municipal earnings tax. Id. at 613-14. As the court explained: “The city’s position that it may extract a tax from employees based on sums they have not received and may never receive is simply
untenable.” Id. at 614.

3 The Thrift Savings Fund also contains other assets such as contributions made by governm ent agencies that em ploy the federal workers who participate in the TSP 5USC § 8437(b), see also id. § 8479(b)

143Opinions o f the Office o f Legal Counsel

The Whipple court, of course, did not address the validity of municipal earningstaxes imposed upon federal employees who partake of the TSP program. Nevertheless, as your letter points out, under the Supreme Court’s ruling in Davis v. Michigan Department of the Treasury, 489 U.S. 803 (1989), neither states nor municipalities may differentiate between similarly situated federal employees and state or municipal employees in levying state and local taxes. This restriction flows from the constitutional principle of intergovernmental tax immunity and 4 U.S.C. §111, which states:

The United States consents to the taxation of pay or compensation for personal service as an officer or employee of the United States . . . by a duly constituted taxing authority having jurisdiction, if thetaxation does not discriminate against the officer or employee because o f the source of the pay or compensation.

4 U.S.C. § 111 (emphasis added). Interpreting this provision in conjunction with the constitutional conception of intergovernmental tax immunity, see Davis, 489 U.S. at 813 (characterizing § 111 and modern constitutional doctrine as “coextensive”), the Supreme Court concluded that intergovernmental tax immunityprecludes taxation of federal employees “to the extent that such taxation discriminates on account of the source of the compensation.” Id. at 810. Applying this rule, the Court held that the State of Michigan could not levy an income tax on retirement benefits paid by the federal government while exempting from taxation retirement benefits paid by the state or its political subdivisions. Id. at 814-17. Simply put, the Michigan taxation scheme failed because the inconsistent treatment of state and federal employees was not “directly related to, and justified by, ‘significant differences between the two classes.’” Id. at 816 (quoting Phillips Chem. Co. v. Dumas Indep. Sch. Dist., 361 U.S. 376, 383 (I960)). The Supreme Court applied this understanding of the rule of intergovernmental tax immunity in Barker v. Kansas, 503 U.S. 594 (1992), where the Court struck down a Kansas scheme that levied taxes on the benefits paid to military retirees but exempted benefits received by retired state and local government employees.Again, the Court emphasized that it “evaluate[s] a state tax that is alleged to discriminate against federal employees in favor of state employees by inquiring ‘whether the inconsistent tax treatment is directly related to, and justified by, “significant differences between the two classes.’”” Id. at 598 (quoting Davis, 489 U.S. at 816) (quoting Philips Chem., 361 U.S. at 383). Not surprisingly, the Court invalidated the Kansas taxation scheme by applying this basic principle. Id. at 598-605.

144The Need To Withhold and Rem it Local Earnings Taxes

III.

The issue raised by your inquiry must be resolved through the application of the principle set forth in Davis and Barker. By judicial decision, the sums paid to the Missouri Police Department Deferred Compensation Fund are exempt from the Kansas City earnings tax. See Whipple, 779 S.W2d 610 (Mo. Ct. App. 1989). In contrast, the voluntary TSP contributions of federal employees historically havebeen subject to the Kansas City earnings tax. The validity of the taxation of voluntary TSP contributions turns on “whether the inconsistent tax treatment is directly related to, and justified by, ‘significant differences between the two
classes.’” Davis, 489 U.S. at 816 (quoting Philips Chem., 361 U.S. at 383); accord Barker, 503 U.S. at 598. We believe that a significant difference betweenvoluntary TSP contributions and sums paid to the Missouri Police Department Deferred Compensation Fund justifies the existing disparity in tax treatment. Voluntary TSP contributions are held in trust for the benefit of the employees who participate in the plan. See 5 U.S.C. § 8437(g). The legal nature of the Thrift Savings Fund creates a legitimate and enforceable expectation of the return ofcontributions to TSP participants. Indeed, this is precisely what Congress anticipated. See S. Rep. No. 99-166, at 14 (1985), reprinted in1986 U.S.C.C.A.N. 1405, 1419 (“Employees are immediately vested in their own contributions and earnings attributable to them. . . . At retirement an employee may withdraw the account balance either in a lump sum . . . or in installments.”); H.R. Conf. Rep. No. 99-606, at 134-135 (1986), reprinted in 1986 U.S.C.C.A.N. 1508, 1517-1518 (adopting provision for full and immediate vesting of both employer and employee contributions, and discussing options for withdrawal of contributions). In comparison, the return of any sums paid to the deferred compensation plan at
issue in Whipple is essentially speculative. As the Whipple court explained:

[A participating employee’s] account reflects the current status of the employee’s prospective benefits, but the account is the property
of the board

.... The sole interest of the employee in his deferredcompensation is the unsecured promise of the board to pay the employee whatever balance may be in the account at the employee’s retirement or separation from the department.

Whipple, 779 S.W.2d at 611. Indeed, the deferred compensation plan included language that qualified each participant’s claim to any sums paid at a participant’s direction to the plan:

All amounts of Compensation deferred under this Plan, all property and rights which may be purchased by the Employer with such amounts and all income attributable to such amounts, property or

145Opinions o f the O ffice o f Legal Counsel

rights to property shall remain the sole property and rights of the Employer without being restricted by the provisions of this Plan subject only to the claims of the Employer’s general creditors. The obligation of the Employer under this Plan is purely contractual and shall not be funded or secured in any way.

Id. Based on these provisions, the court of appeals concluded that an “employee has no guarantee that any payment of deferred compensation will be made.” Id. at 612. The provisions of the deferred compensation plan discussed in Whipple, whichsignificantly qualified the claims of participants to payments made at their direction, render sums paid to the plan in Whipple readily distinguishable from voluntary TSP contributions. Thus, Kansas City and St. Louis cannot be forbidden, by either the constitutional principle of intergovernmental tax immunity or by 4U.S.C. § 111, to impose a municipal earnings tax upon voluntary TSP contributions. Unless a Missouri court rules that earnings taxes cannot be levied upon voluntary TSP contributions as a matter of state law, the Kansas City and St. Louis earnings taxes should be withheld and remitted for voluntary TSP contributions.4

IV.

Your request for an opinion on the validity of earnings taxes levied by Missouri municipalities necessitated a comparison of voluntary TSP contributions and sumspaid to a specific deferred compensation plan that are exempted, by a judicial ruling, from the earnings tax. Our analysis turns upon a material distinction between the two types of contributions. We find, based upon this material distinction, that intergovernmental tax immunity does not foreclose the imposition of an earnings

4 Y our inquiry assum es that voluntary T S P contributions “are not included in an em ployee’s gross wages for Federal incom e tax purposes ” This fact, how ever, does not affect our analysis of the intergovernm ental lax im m unity issue As a general matter, states and m unicipalities may tax earnings that are exem pt fromtaxation under the Internal R evenue Code, and the earnings taxes levied by K ansas City and St. Louis apparently sw eep m ore broadly than the federal incom e lax laws See Whipple, 779 S W .2d at 613 n 3 T o be sure, a T S P participant could challenge, under M issoun law, the application o f the earnings tax to TSP contributions by filing a declaratory judgm ent action in state court. Indeed, the Whipple decision strongly suggests that such an action would be successful. Id. at 613-14 & n 3. As the Whipple court ob ­ served, a M issouri statute proscribes the taxation of any paym ent made to a deferred com pensation program “ ‘to the sam e extent as it is exem pt from incom e tax im posed by the United S t a t e s . Id. at 613 (quoting and interpreting M o. A nn Stat. § 105.900.2) T his statute, when read in conjunction with lim itations im posed by M issouri law upon the taxing authority of m unicipalities, prom pted the W hipple court to opine that Kansas C ity lacked the capacity under state law to tax such paym ents as earnings. Id. at 613-14 & n 3 This argum ent m ight well be persuasive m a declaratory judgm ent action sn a M issoun court, but u is not the province of this O ffice to issue authoritative interpretations o f state laws and m unicipal codes. See L etter for H on W endell H. Ford from M ary C. Lawton ai 3 (A pr. 5, 1976) (explaining that “we o f course are not in a position to give an authoritative interpretation of State law ”); cj. Pennhurst State Sch. & Hosp. v H alderm an , 465 U S. 89, 106 (1984) (noting im propriety of federal courts instructing stale officials “on how to conform their conduct to state law”). H ence, our opinion does not address the validity of ihe municipal earnings taxes as a m atter o f M issoun law.

146The Need To W ithhold and Rem it Local Earnings Taxes

tax by the Missouri municipalities. Therefore, we anticipate that the NFC will withhold and remit earnings taxes for TSP contributions.

WALTER DELLINGER Assistant Attorney General Office o f Legal Counsel

147