'S iataadaertt >J<*mes H 351*'7i47 tietirenant LlJrtt CaxAtion and ISbl tieneiit update s L12rtb laii STATE OF MONTANA LJfficz of ths -J^egULattue l?LicaL c/fnalyit STATECAPITOL HELENA.MONTANA59620 406/444-2986 TERESAOLCOTTCOHEA LEG,SLAT.VEF,SCAL^^^|^py^^j^^g(,0LLECT10H August 27, 1991 FEB V 199?. MONTANA STATE LIBRARY HELEN15A1,5MEO.N6TtAhNAAVE5.05^- TO: Legislative Finance Committee FROM: Jim Standaert ^£^ Associate Fisc^ Analyst RE: Retirement Taxation and Benefit Update At the June 1991 meeting. Legislative Finance Committee members discussed two court cases concerning taxation of retirement benefits and a legal opinion concerning retirement benefit adjustments. These issues have a potential negative revenue impact of $44.0 million. Following is an update on each issue. 1. Refund of federal retiree income taxes. In May 1989, in the case of Edmund F. Sheehy. et. al. . v. State of Mwitana, a group of retired federal civil service employees and retired military personnel sought: 1) exemption of federal retirement benefits from Montana income taxation, in the same manner as state and local retirement benefits are exempt; and 2) refunds of Montana income taxes paid on federal retirement benefits during the years of 1983 through 1988. The plaintiffs based their case on Davis vs. Michigan which was decided in March 1989. , In that case, the U.S Supreme Court held that exempting retirement benefits of state and local employees but not certain federal employees from state income taxes violated the constitutional principle of intergovernmental tax immunity and the Public Salary Act of 1939. pAQc pniiRw 01 i i . The plaintiffs were successful in the first part of their snit but not in the second. As a result, the Department of Revenue in tax year 1989 began administratively exempting all federal retirement benefits from state income tax. Plaintiffs appealed the second part of the suit to the Montana Supreme Court, claiming income tax refunds for the years 1983 through 1988. Arguments on this issue were heard in June 1991, but no decision has yet been made. As of August 21, 1991, 16,438 amended returns have been filed by 6,005 taxpayers, claiming $12,974,580 in refunds. The Department of Revenue estimates the total cost of making refunds if the plaintiffs are successful is approximately $20 million (including interest) 2. The constitutionality of Senate Bill 226. On May 11, 1991, another suit, Edmund F Sheehv v. State of Montana , was filed in district court challenging the constitutionality of Senate Bill 226. Senate Bill 226, passed by the 1991 legislature, allows a $3,600 exemption from state income taxes for all federal, state, and local retirement benefits for those with federal adjusted gross incomes of $30,000 or less. The exemption is phased out for incomes above $30,000. In addition. Senate Bill 226 increases retirement benefits to state and local retirees who reside in the state by 2.5 percent. The plaintiffs in this case make five claims: 1. Senate Bill 226 violates Article 5, Section 11, paragraph 1 of the Montana Constitution. This paragraph states that "a law shall be passed by bill which shall not be so altered or amended on its passage through the legislature as to change the original purpose". 2. Section 5, paragraph 3a of Senate Bill 226 gives discretionary rulemaking authority to the retirement boards. 2 . 3. The increase in state retirement benefits amounts to a refund of state income taxes and constitutes discriminatory taxation against federal retirees 4. The state has a contract with state retirees to exempt retirement benefits from taxation. Senate Bill 226 is unconstitutional because it violates Article 2, Section 31 of the Montana Constitution which prohibits the legislature from passing any law impairing the obligation of contracts. 5. Senate Bill 226 increases retirement benefits to state retirees who reside in the state. Senate Bill 226 is unconstitutional because it interferes with the plaintiffs' constitutional right to travel and reside in other states. The Department of Revenue responded to these complaints on July 11, 1991. To date, no court decision has been issued. Senate Bill 226 is anticipated to produce $20,862 million net revenue to the general fund and school equalization account during the 1993 biennium. 3 Payment of additional benefits mandated under Senate Bill 226. . Under Section 4 of Senate Bill 226, by May 1 of each year the state treasurer is required to pay to the Public Employees' Retirement Board and the Teachers' Retirement Board an amount equal to 2.5 percent of the total benefits paid by both systems during the previous calendar year. The amount of the benefits to be paid to each board must be certified to the state treasurer by the boards no later than April 1st of each year. The payments of the additional benefits are to be paid to members by June 1st. While the bill is effective for all taxable years after December 31, 1990, the bill was signed into law on May 24, 1991, well after the April 1 deadline for certification to the state treasurer. Hence, no payment was made on June 1, 1991. The retirement boards plan to make the first adjustment payment on June 1, 1992. The Director of the Legal Services Division of the Legislative Council has rendered an opinion that the additional retirement benefit payments should be made in 1991. The estimated general fund cost of this payment would be $3.3 million in fiscal 1992. JS3A:pe:LFA8-26.mem