A Big Case for the Supreme Court Later this Year

The Supreme Court doesn’t decide many tax cases. They’re usually not that interesting, and it’s rare to see a split among the different circuits in a tax issue. However, a very important tax case will be decided in the next Supreme Court term (beginning in October): Department of Revenue v. Davis.

In 2006 the Kentucky Court of Appeals (the Kentucky Supreme Court declined to hear the case) held that, “…[W]e find that Kentucky’s tax on the income derived from bonds issued outside Kentucky violates the Commerce Clause of the United States Constitution, we vacate and remand.”

Why is this important? If you live in a state with a state income tax, and you own municipal bonds issued by your state, you do not pay income tax on those bonds. However, if you own bonds issued by another state you almost certainly do pay income tax on those bonds. The Kentucky ruling says that’s illegal—it violates the dormant commerce clause of the U.S. Constitution.

To no one’s surprise, the National Association of State Treasurers doesn’t like this ruling; they will be filing an amicus brief on the case. The Kentucky Department of Revenue doesn’t like the ruling; it will cost the state money. Indeed, high tax states (and Kentucky is not one of those) like this ruling even less. If the Court of Appeals ruling is upheld, bonds issued by high tax states (such as California) will need to pay a higher interest rate, costing the states money.

The case will be heard late this year; a decision isn’t likely to be announced until early 2008. If you own municipal bonds from a state other than your own, pay attention to the decision. If you paid enough tax from these bonds and the ruling is upheld by the Supreme Court, you may be able to amend your state tax return seeking a refund of tax.

The TaxProfBlog has more on this case, and you can find news stories at Bloomberg and elsewhere.

Hat Tip: TaxProfBlog

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