are states knowingly enacting unconstitutional tax laws?

States balance their budgets each year and use the revenue they receive to run programs. When laws are ruled unconstitutional and refunds are required to be paid, it puts a state in a tough position. Sometimes states enact new retroactive legislation to mitigate or eliminate the amount of refunds that would have been required to be paid out under the reversal of an unconstitutional law. 

Note:  I wrote my thesis on this very topic as part of my masters in taxation degree several years ago. However, the issue remains alive and well today.

When a state enacts legislation that later is found to be unconstitutional, what is the appropriate remedy?

  • Prospective relief only?
  • Retroactive refunds for all taxpayers for all years still open under statute?
  • Retroactive refunds for only those taxpayers that have filed protective refund claims?
  • Or better yet, should states be allowed to change the unconstitutional legislation/statute in such a way as to make it constitutional? If yes, should states be allowed to make that change retroactive to limit the amount of refunds they will have to pay to taxpayers who paid the tax in prior years (or filed protective refund claims)?

The answers to these questions have been played out in several states over the years. Unfortunately, a state is usually allowed to enact retroactive legislation and reduce the economic pain of paying refunds. 

State Budgets + Political Pressure = Unconstitutional Taxes and Fees?

When states are concerned about their budgets and face political pressures, governors and legislatures often enact, knowingly or unknowingly, unconstitutional state taxes or fees. When states need new revenue (without "raising taxes” or political “fall-out"), certain fees or taxes become attractive alternatives. However, those alternatives may be unconstitutional.

It seems not only unfair, but perhaps “illegal,” for states to collect taxes by enacting laws later to be found unconstitutional, and then refuse to give the money back to taxpayers. A state should not be allowed to profit from collecting taxes it should not have been allowed to collect in the first place.

The Current Problem

Currently, states are knowingly enacting or attempting to enact potentially unconstitutional sales tax collection laws on remote sellers (see Alabama). States are trying to overturn or 'drive around' the Quill Corp. v. North Dakota decision that requires retailers to have a physical presence in a state before the state can require the retailer to collect sales tax on its in-state sales. States are forcing taxpayers to challenge these laws with the hopes the U.S. Supreme Court will accept a case and overturn Quill.

The U.S. Court of Appeals for the Tenth Circuit recently ruled in Direct Mktg. Ass'n v. Brohl (DMA) that Quill did not apply to Colorado's sales tax reporting requirement since Colorado's law was not requiring sales tax collection. Even though the DMA decision did not fall under the application of Quill, Quill was referred to throughout the case. Consequently, if the taxpayer appeals the case, states are hoping the U.S. Supreme Court will take the case and somehow use it to overturn Quill.

The attempt to overturn Quill by enacting laws that are obviously overreaching at best, unconstitutional at worst, puts taxpayers in a difficult predicament. The options are (1) compliance, (2) comply and challenge, or (3) explicitly refuse to comply and challenge the law in court. All of these options are a win for the state and a loss for the taxpayer.

Questions Remain

  1. Will Congress enact the Marketplace Fairness Act?
  2. Will the U.S. Supreme Court accept a case challenging Quill? If it does, will it overturn Quill or reinforce it?
  3. Will the states continue to aggressively skirt Quill regardless of the action or inaction by Congress or the U.S. Supreme Court?

Stay tuned.