Opinion ID: 1757198
Heading Depth: 1
Heading Rank: 1

Heading: entitlement to refund

Text: Before its amendment, effective July 13, 1990, KRS 141.021 exempted state retirement annuities, regardless of amount, from state income tax, but exempted federal retirement annuities only up to $4,000. In 1989, the United States Supreme Court held a similar Michigan statute violative of the federal constitutional doctrine of intergovernmental tax immunity. Davis v. Michigan Dept. of Treasury, 489 U.S. 803, 109 S.Ct. 1500, 103 L.Ed.2d 891 (1989). In response to the Davis decision, Kentucky's General Assembly in 1990, exempted all federal retirement benefits from state income taxation, thereby treating the retirement benefits of retired state, local and federal governmental employees equally. (See KRS 141.021, effective July 13, 1990.) Following the Davis decision, federal retirees residing in Kentucky (Gossum, et al.), filed a class action in Marshall Circuit Court seeking refunds of taxes paid on any federal retirement benefits received during the five-year period preceding the Davis decision. The Revenue Cabinet conceded that the statute was invalid, but contested the refund issue by questioning the retroactivity of Davis . The circuit court reasoned that inasmuch as the Commonwealth has consented by statute to refund taxes paid under an unconstitutional provision (KRS 134.590), the retroactivity of Davis is essentially a moot question; refunds being in order as a matter of state law. The trial court also ruled: a) that the two-year limitation period in the case of taxes held unconstitutional (KRS 134.590), as opposed to the four-year period for other refunds (KRS 134.580 and KRS 141.235), does not violate due process or equal protection, because there is a reasonable basis for, and a legitimate state interest in, the distinction, b) that the taxpayers must pursue their refunds under KRS 134.590, whereunder refunds may be available only for the two years preceding the year in which this litigation was commenced, and c) that because the amount of taxes due is in litigation, subsection (6) rather than subsection (2) of KRS 134.590 governs the time for which applications for refunds must be made, i.e., within two years from the date the amount due is determined through this litigation. Both sides appealed, putting all of the trial court's major rulings in issue. Appellants contend that federal law does not require Kentucky to refund income taxes paid by federal retirees on federal retirement benefits if a procedure exists to challenge the tax in question before it is paid. In Harper v. Virginia Dept. of Taxation, 509 U.S. ___, 113 S.Ct. 2510, 125 L.Ed.2d 74 (1993), the United States Supreme Court concluded that the Virginia Supreme Court decision that denied retroactivity of Davis was in error. ( See Harper v. Virginia, Dept. of Taxation, 241 Va. 232, 401 S.E.2d 868 [1991].) The United States Supreme Court also held that the state court had erroneously applied the factors set forth in Chevron Oil Co. v. Huson, 404 U.S. 97, 92 S.Ct. 349, 30 L.Ed.2d 296 (1971), in denying relief to petitioners therein, as to all taxable events occurring before Davis was decided. Harper is unambiguous in its holding that Davis applies retroactively, without resort to the test for retroactivity articulated in Chevron, supra . However, the Supreme Court therein did not mandate payment of refunds to the Virginia retirees, but rather concluded that federal law does not necessarily entitle (the federal retirees) to a refund. Instead, the United States Supreme Court remanded the case to the Supreme Court of Virginia to provide relief consistent with federal due process principles. ( See Harper v. Virginia, Dept. of Taxation, 242 Va. 322, 410 S.E.2d 629 [1991].) Thus, the U.S. Supreme Court ruled that if Virginia provided its federal retirees with an opportunity to obtain relief in a predeprivation hearing prior to requiring payment of the tax, no refund of taxes paid by federal retirees was federally mandated. The Supreme Court defined the procedures which would qualify for federal due process purposes as: predeprivation processes as an opportunity that exists for the contesting taxpayer to be permitted under state law to bring suit to enjoin imposition of a tax prior to its payment, or by allowing taxpayers to withhold payment and then interpose their objections as defenses in a tax enforcement proceeding. See Reich v. Collins, 263 Ga. 602, 437 S.E.2d 320 (1993). See James B. Beam Distilling Co. v. Georgia, 501 U.S. 529, 111 S.Ct. 2439, 115 L.Ed.2d 481 (1991), wherein the United States Supreme Court required retroactivity and disagreed with using the Chevron Oil analysis. See also Hagge v. Iowa Dept. of Revenue and Finance, 504 N.W.2d 448 (Iowa 1993), wherein the Supreme Court of Iowa ordered refunds to be paid as Iowa did not provide the type of predeprivation remedies mandated by Harper. We arrive at the question of whether Kentucky provides predeprivation remedies which are adequate to satisfy the due process requirements established in Harper. Where no such meaningful predeprivation procedures exist, then a state is constitutionally required to provide its citizens with backward-looking relief. McKesson Corp. v. Division of Alcoholic Beverages and Tobacco, 496 U.S. 18, 110 S.Ct. 2238, 110 L.Ed.2d 17 (1990) and Harper, supra. The Revenue Cabinet asserts that because a taxpayer may seek review of an assessment without first paying the tax, these procedures constitute sufficient predeprivation remedies and, thus, no backward-looking relief is required under federal law. Kentucky's system is structured so that a taxpayer is coerced into paying the tax in advance to avoid financial sanctions. The Supreme Court has held that in such cases the due process clause of the Fourteenth Amendment obligates the state to provide meaningful backward-looking relief to rectify any unconstitutional deprivation. We have long held that, when a tax is paid in order to avoid financial sanctions or a seizure of real or personal property, the tax is paid under duress in the sense that the State has not provided a fair and meaningful predeprivation procedure. . . . McKesson, supra . Any Kentucky taxpayer who fails to file an income tax return or to pay income taxes when due under KRS Chapter 141 is subject to an array of fines and civil and criminal penalties. KRS 141.990; KRS 131.180. Civil penalties for failure to make payments or file returns can be as much as 20% of the total tax due. If a taxpayer does not make an estimated payment when due (or underpays an estimate), he is subject to a penalty of as much as 10% of the amount. If the Cabinet's assessment is deemed the result of the taxpayer's negligence, an additional 10% penalty is levied; if the assessment is determined to be the result of taxpayer fraud, the penalty jumps to 50%. If it is determined that the tax was willfully withheld, the taxpayer is guilty of a Class D felony. Furthermore, all taxes payable to the state which are not paid when due thereafter accrue interest at the adjusted prime interest rate. KRS 131.183. Under KRS 131.180(4), if a taxpayer fails to timely file a return, the Revenue Cabinet may estimate the tax due, assess the tax at twice the amount estimated to be due, and then impose a penalty up to an amount equal to 50% of the assessed amount. The Commonwealth also has broad powers to require immediate payment of taxes prior to any challenge to an assessment if it believes that any tax claim for any . . . reason is being endangered. The taxpayer's only recourse becomes filing a bond to avoid garnishment. And, only after the bond is filed can a taxpayer challenge the assessment. Finally, a taxpayer cannot escape some payment where he has failed in his challenge to an assessment at the Board of Tax Appeals, and desires to appeal the matter to circuit court. KRS 131.370(3) requires the taxpayer to file a supersedeas bond, or pay the tax, before pursuing the matter in circuit court. Because the statutory scheme is pointedly designed to coerce taxpayers into remitting taxes before challenging any liability to avoid potential economic disadvantage, Kentucky does not offer meaningful, adequate predeprivation remedies for purposes of federal law. Moreover, there is nothing in the statutes relating to declaratory and injunctive relief proceedings that would permit taxpayers to withhold payment pending resolution of their claims. The Cabinet's argument against appellees' motion for injunctive relief reflects that such actions do not constitute adequate predeprivation remedies. It asserted that appellees were not entitled to an injunction to preclude the collection of the tax for 1989, because if the court ultimately rules in their favor, the taxpayers have a means by which they can receive the statutorily authorized remedy of tax refunds. In Hagge, supra , the Iowa Supreme Court held that their state did not offer meaningful predeprivation remedies as required by federal law as, although the state no longer expressly required prepayment of tax, interest and penalties before contesting an assessment, we are convinced that, by McKesson standards, tax payment in Iowa continues to be less `voluntary' than `under duress.' Moreover, state law requires relief beyond consideration of the demands of federal due process as the Kentucky legislature has enacted refund statutes that provide that Kentucky taxpayers who have paid taxes above what they are legally required to remit are entitled to refunds. KRS 134.580, KRS 134.590 and KRS 141.235. In Brumley v. Utah State Tax Commission, 868 P.2d 796 (Utah 1993), the court held that plaintiffs were entitled to refunds under Davis for those taxes paid on their retirement benefits, even though Harper provides some latitude to the states to craft a remedy for the illegal exaction of taxes because their legislature had provided refunds to be the appropriate remedy. Because the General Assembly decreed that the Commonwealth is required to make the statutorily authorized remedy of tax refunds where a person has been improperly taxed, then that is the minimum remedy available under Kentucky law. We find no merit to Revenue Cabinet's contention that no refunds are due or owing insofar as no statute was declared unconstitutional. It is the obvious intent of the refund statutes to provide a remedy to taxpayers who were taxed pursuant to an unconstitutional tax, which is all inclusive of an unconstitutional taxing scheme. The facts in this case clearly fall within the refund statutes. Therefore, we hold that Kentucky fails to provide meaningful adequate predeprivation processes as required by Harper, thereby invoking the retroactivity of Davis and entitling the federal pensioners to a refund of taxes previously paid pursuant to KRS 141.021.