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Can You Attack State and Local Taxes Under the State's Constitution?

Truths and myths revealed.

November 29, 2007
by John Karayan, JD/PhD

Many international tax concepts apply to state and local taxation because both areas deal with cross-border transactions. A good example can be found among the lore of U.S. tax practice: the myth that taxpayers really cannot attack state or local taxes under the state’s constitution. Although case law is littered with unsuccessful attempts to invalidate taxes under state constitutions, a recent case illustrates that some attempts can succeed. Ohio Grocers Association v. Wilkins, Court of Common Pleas, Franklin County, Ohio Civil Division, Case No. 06CVH02-2278, August 24, 2007 (Notice of Appeal filed October 3, 2007).

Attacks under state Constitutions usually parallel those under the Equal Protection Clause of the Fourteenth Amendment to the U.S. Constitution. The question in these cases is one of basic fairness: Are any distinctions made among different taxpayers to pursue a legitimate governmental interest? This is a fairly low standard, with courts increasingly reluctant to second-guess the bona fides of elected officials (e.g., Exxon Corp. v. Eagerton, 462 U.S. 176 (1983)). Nevertheless, taxpayers occasionally win, e.g., MCI Telecommunications Corp. v. Limbach, 625 N. E. 2d 597 (Ohio Supreme Court 1994).

Unlike the U.S. Constitution — a model of brevity and focus — the Constitutions of our nation’s states tend to be long, detailed and unfocused. State and local taxes that do not meet the various and sundry requirements of their own state’s Constitution can, and occasionally are, invalidated upon challenge in court. The most common of these cases deal with “uniformity” clauses, inserted into state Constitutions for much the same reasons that Article 1, Section 8 of the U.S. Constitution requires that “all Duties, Imposts and Excises shall be uniform throughout the United States.”

Successful Attack Tactics

A recent taxpayer uniformity clause win can be found in Clifton v. Allegheny County, No. GD05-028638, Court of Common Pleas of Allegheny County, June 6, 2007. There, a state court of appeals invalidated statewide real property tax assessment rules under the uniformity clause of the Pennsylvania Constitution. These rules let county property tax assessors estimate the fair market value of parcels by extrapolating from a “base year market value,” and do so indefinitely. More typical is the recent taxpayer loss in Exelon Corp. v. Illinois Department of Revenue, Illinois Appellate Court, First District, No. 1-06-3388, September 24, 2007. There, the court rejected a challenge to property tax that is allowed for natural gas companies but was denied to a firm supplying electricity. The court noted that the uniformity clause of the Illinois Constitution did not require equal treatment, but only that any distinctions be “reasonable.”

Ohio Grocers illustrates the intriguing possibility that tax laws can be invalidated because they run afoul of a fairly unique rule in a particular state’s Constitution. At issue in this case was the validity of the Ohio “commercial activity tax.” This is a tax measured by the gross receipts of a firm doing business in Ohio, including receipts from sales of food. The plaintiffs attacked the tax on the grounds that, as applied to grocers, it violated Secs. 3(C) and 13 of Article XII of the Ohio Constitution. These sections prohibit excise taxes on the sale of food, and most likely ban sales taxes on food sold in grocery stores. The court rejected their claim, arguing that, like Certs, the commercial activity tax was two taxes in one — both a franchise tax and an excise tax. Thus, because all gross receipts were included in the tax base, and not just retail sales, the commercial activity tax was not an excise tax on the sales of food.

Nevertheless, Ohio Grocers illustrates the point that taxpayers can successfully attack state and local taxes under state Constitutions, and there may be fairly unique provisions which come into play.

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John E. Karayan, JD/PhD is Professor & Chair of Accounting at Woodbury University, and a testifying Expert Witness in complex business litigation on accounting and tax issues.