Tax immunities

Constitutional principle that exempts federal and state government agencies, activities, and property from taxation by one another.

The U.S. Constitution does not expressly immunize the federal government from state taxation, nor the states from federal taxation. However, in McCulloch v. Maryland[case]McCulloch v. Maryland[MacCulloch v. Maryland] (1819), the Supreme Court inferred the federal government’s immunity from Article VI, section 2, the supremacy clause, of the U.S. Constitution. McCulloch held that Maryland could not impose a tax on notes issued by the Bank of the United States because a state may not tax those it does not represent. Otherwise, any state could use its taxing power “to retard, impede, burden, or…control” the federal government, which the Constitution declared to be supreme in exercising its delegated powers. McCulloch did not directly address the issue of federal taxation of state governments but suggested that states did not enjoy reciprocal immunity.

Later Immunities

After McCulloch, however, the Court inferred state taxState taxation immunity from the Tenth AmendmentTenth Amendment and crafted the doctrine of intergovernmental tax immunity defined by the principle of dual federalismDual federalism. The Court began by extending doctrine from the primary immunity of government itself to bar taxation by one government of the employees of another. Dobbins v. Erie County[case]Dobbins v. Erie County[Dobbins v. Erie County] (1842) invalidated a state tax on a federal officer, and Collector v. Day[case]Collector v. Day[Collector v. Day] (1871) held that the salaries paid state judges were immune from federal taxation. The Court further extended state immunity to protect increasingly diverse state proprietary activities, such as utility and railroad operations, and private businesses selling goods to state governments. Then in Pollock v. Farmers’ Loan and Trust Co.[case]Pollock v. Farmers’ Loan and Trust Co.[Pollock v. Farmers’ Loan and Trust Co.](1895), the Court held that the interest earned from state bonds was immune from federal taxation. The Court also expanded the doctrine of intergovernmental tax immunity to bar state taxation of private businesses selling goods to and leasing land from the federal government because the economic incidence or burden of the tax would be passed on to the federal government. In Long v. Rockwood[case]Long v. Rockwood[Long v. Rockwood] (1928), it even made royalties on federally issued patents immune from state income taxation.

These increasingly expansive interpretations deprived federal and state governments of substantial revenues and moved the Court to narrow the scope of intergovernmental tax immunities in the late 1930’s. In James v. Dravo Construction Co.[case]James v. Dravo Construction Co.[James v. Dravo Construction Co.] (1937), the Court discarded the economic incidence test, limited federal tax immunity to its legal incidence, and upheld a nondiscriminatory state tax on a private business that had built locks and dams under a federal contract because the federal government did not have a direct legal obligation to pay the tax. Then the Court’s decision in Helvering v. Gerhardt[case]Helvering v. Gerhardt[Helvering v. Gerhardt] (1938) overruled Day, permitting the federal government to levy a nondiscriminatory income tax on state civil servants. Finally, in Graves v. New York ex rel. O’Keefe[case]Graves v. New York ex rel. O’Keefe[Graves v. New York ex rel. O’Keefe] (1939), the Court overruled Dobbins and permitted nondiscriminatory state taxation of federal employees. After Graves, the intergovernmental tax immunity doctrine became even more limited, barring only taxes imposed directly on one government by another and taxes that discriminated against the employees and private businesses who had dealings with the government.

Federal Tax Immunity

Federal tax immunity exists only when the legal incidence of the tax falls directly on the federal government, its property, or one of its entities. The Court further limited the immunity of federal employees from state taxation in United States v. County of Fresno[case]County of Fresno, United States v.[County of Fresno, United States v.] (1977), in which it upheld a state tax on the use by federal employees of housing supplied to them by the U.S. Forest Service as part of their compensation because the tax was similar to a state tax on the owners of nonexempt property who passed the economic incidence on to their renters. States may not, however, impose discriminatory taxes on federal employees. In Davis v. Michigan[case]Davis v. Michigan[Davis v. Michigan] (1989), the Court rejected a state income tax on federal government employee retirement benefits that exempted state employee retirement benefits from taxation.

Private businesses that use federal property are no longer immune from nondiscriminatory state taxes. In Detroit v. Murray Corp.[case]Detroit v. Murray Corp.[Detroit v. Murray Corp.] (1958), the Court sustained state taxes on a private company’s use of machinery owned by the federal government and leased to the company for use in the business. In a companion case, United States v. Detroit[case]Detroit, United States v.[Detroit, United States v.] (1958), it upheld a state tax on those who used tax exempt federal property because the state had imposed a similar tax on the owners of nonexempt private property. After United States v. New Mexico[case]New Mexico, United States v.[New Mexico, United States v.] (1982), the Court took a narrow approach in determining federal tax immunity. New Mexico rejected the claim that private contractors were federal agents who were paid by an advanced funding procedure because the private taxpayer and the government must be so closely connected that the taxpayer “stands in the government’s shoes.”

State Tax Immunity

Although the immunity of the federal government and its entities has not been at issue since 1937, the Court limited state tax immunity to the performance of its basic governmental functions. In New York v. United States[case]New York v. United States[New York v. United States] (1946), it rejected the distinction between government and proprietary activities as unworkable in an age of increasingly diverse state governmental activities and articulated a new state immunity principle that permitted a federal nondiscriminatory tax to be applied to the state’s bottling and sale of water. The Court further limited the reach of the state immunity doctrine in Massachusetts v. United States[case]Massachusetts v. United States[Massachusetts v. United States] (1977), in which the Court sustained the application of a federal annual registration tax on civil aircraft to a state police helicopter because it was based on a fair approximation of the state’s use of the national aviation system. After Massachusetts, the federal government could tax even a basic state government activity if the nondiscriminatory tax recoups the cost of benefits received from the federal government.

Tax immunities Summary