Pending Litigation May Affect Taxation of Municipal Bonds
In a case pending at the U.S. Supreme Court, Kentucky Department of Revenue vs. Davis, Docket 06-666, the question of the constitutionality of tax exemption of bonds issued by a State and its subdivisions is at issue. Kentucky exempts from state income taxation the interest earned on bonds issued by Kentucky and its political subdivisions, but does not provide a similar exemption for bonds issued by other states. The Kentucky Court of Appeals held that the Kentucky tax statutes violate the dormant Commerce Clause, concluding that “Kentucky’s bond taxation system is facially unconstitutional as it obviously affords more favorable taxation to in-state bonds than it does to extra-territorially issued bonds.” The court also rejected Kentucky’s “market participant” argument, reasoning that Kentucky acts as a market regulator—not a market participant—when it imposes a tax on interest income. The question presented then is whether a state violates the dormant Commerce Clause by providing an exemption from its income tax for interest income derived from bonds issued by the state and its political subdivisions, while treating interest income realized from bonds issued by other states and their political subdivisions as taxable to the same extent, and in the same manner, as interest earned on bonds issued by commercial entities, whether domestic or foreign.
Although Wisconsin's law differs somewhat from Kentucky's law, Wisconsin law could still be affected by the outcome of this case, depending on how the Supreme Court rules.
In order to extend the statute of limitations for the department to issue a refund in the event that the U.S. Supreme Court rules the Kentucky law violates the dormant Commerce Clause and is applicable to Wisconsin’s law, persons who paid income tax on interest similar to that at issue in the Kentucky Davis decision may enter into an agreement extending the time to file a claim for refund with the Wisconsin Department of Revenue. Both parties must sign the agreement before the statute of limitations expires. A copy of the agreement form is reproduced Agreement Extending Time to File Claim For Refund.
If you have any questions regarding this issue, please contact Dawn Wenzel at (608) 266-3190.
Last updated January 8, 2008