Multistate Tax Update -- March 12, 2015

US Supreme Court hears oral arguments on the Affordable Care Act’s tax credit provision

Last week, the Supreme Court heard oral arguments in King v. Burwell, one of the most anticipated cases of the year. The case focuses on whether the premium tax credit provision of the 2010 Patient Protection and Affordable Care Act (ACA) is legal and whether the statute permits individuals to receive a tax subsidy when they purchase their health insurance on a federally established exchange. The premium tax credit is critical to purchasers who live in any of the 34 states that have not established their own healthcare exchanges.

The government argues that the law permits the subsidy when the words “established by the state” are viewed in the context of the entire statute. Indeed, elsewhere there is language that extends premium payment assistance to anyone who is enrolled in one or more qualified health plans through “an exchange.” And in another provision, an exchange is defined as “any exchange, regardless of whether the exchange is established by a state or the Health and Human Services.”

On the other hand, the challengers contend that the actual language says, and means, that only those who purchase their insurance on an exchange “established by the state” can receive a subsidy.

The New York Times reported that the above mentioned 34 states decided not to set up their own exchanges after Congress passed the ACA, leaving their citizens to purchase health insurance on a federally established marketplace. Now, more than nine million people receive subsidies, which average $3,000 per person. Should the Supreme Court agree with the challengers that Congress had no intention of subsidizing health insurance purchased on a federal exchange, most of those nine million people would likely pull out of the exchange, driving prices up for everyone else.

The Tax Foundation analyzed how the annual subsidies would trend through 2018 and concluded that there would be a more than six-fold increase. In 2014, the first year of the subsidies, they amounted to $15.5 billion. By 2018, they would reach $100 billion.

SCOTUSBlog rounded up many news outlets’ reports after the oral arguments were held. Oliver Roeder at FiveThirtyEight, cited the “wisdom of the crowd” and predicted that the government would prevail, leaving the ACA intact.

Predicting the same outcome but employing a different analysis, Jeffrey Toobin, writing for The New Yorker, indicated that most of the justices’ positions were predictable. He opined that all four of the Democratic appointees (Justices Ginsburg, Breyer, Sotomayor, and Kagan) were likely to uphold the law as is, and three of the Republican appointees (Justices Scalia, Alito, and Thomas) would probably not, leaving Justice Kennedy and Chief Justice Roberts. According to Toobin, Justice Kennedy seemed inclined to defer to the executive branch’s own interpretation, a principle known as Chevron deference, though he also expressed sympathy for the challengers’ interpretation.

Toobin noted that the chief justice “scarcely said a word throughout.” But when he did, he pursued the Chevron deference reasoning, and suggested that a new administration could interpret the law differently.

Toobin’s analysis ultimately offered the possibility that Chief Justice Roberts might be loathe to limit presidential powers of statutory interpretation by siding with the challengers. But in so doing, he could insert a reminder that “a new election is fast approaching…[and] that a new president could undo the current president’s interpretation of Obamacare as soon as he (or she) took office in 2017. In other words, the future of Obamacare should be up to the voters, not the justices.”

The opinion is expected by late June.

Colorado: US Supreme Court holds that the Tax Injunction Act does not bar a federal lawsuit

Last December, the United States Supreme Court (the Court) heard oral arguments in the case Direct Marketing Association v. Brohl. There, the Court considered whether the Direct Marketing Association (DMA) had standing to assert its claim that a 2010 Colorado law is unconstitutional, as previously detailed.

The law at issue requires out-of-state online retailers that do not collect Colorado state sales and use taxes to notify customers of the amount of taxes they owe; and that they are obligated to pay those taxes. It also requires remote sellers with sales of more than $100,000 to report the amount of tax owed to the state.

The DMA challenged this law as violation of the Commerce Clause, arguing that it imposes unduly burdensome information collecting and reporting requirements. The district court agreed, and Colorado appealed to the 10th Circuit Court of Appeals (the 10th Circuit). That court determined that the Tax Injunction Act (TIA) barred it from hearing the case in the first place, based on TIA language providing that the federal courts lack the authority to interfere with the assessment, levy, or collection of any tax under state law when the same could be done in state court.

The DMA appealed this decision to the United States Supreme Court, where the only issue was whether the 10th Circuit was correct in concluding that the DMA could not bring its suit to a federal court.

The holding

Reversing the 10th Circuit, the Supreme Court held that the federal court does have jurisdiction over the lawsuit. Writing a unanimous opinion for the Court, Justice Thomas concluded that the terms “assessment,” “levy,” and “collection” in the TIA “do not encompass Colorado’s enforcement of its notice and reporting requirements.” Instead, these terms “refer to discrete phases of the taxation process.” Such phases do not include the sort of informational notices and private reports addressed in the law that have “long been treated as a phase of tax administration that occurs before assessment, levy, or collection.”

Implications

According to SCOTUSBlog, what makes this case exciting is Justice Kennedy’s concurrence. Proclaiming that “[t]he opinion of the Court has my unqualified join and assent, for in my view it is complete and correct,” he added that his separate statement was appropriate and necessary “concerning what may well be a serious, continuing injustice faced by Colorado and many other states.”

The injustice to which Justice Kenney refers is the holding in the 1992 case Quill Corp. v. North Dakota, which reaffirmed a 1967 decision denying states the ability to require a business to collect use taxes if that business does not have an in-state physical presence. Though the use taxes are still due, Quill affirmed the proposition that the state may not require businesses to collect them.

Justice Kennedy suggested that “contemporary Commerce Clause jurisprudence might not dictate the same result.” He reasoned that “there is a powerful case to be made” for imposing a “minor tax collection duty” when a retailer does extensive business in a state, even if via the mail or Internet. That powerful case, in part, exists in lost revenues. Justice Kennedy noted that Colorado collects only about four percent of the tax revenues due on sales from out of state vendors, and in 2012, it lost an estimated $170 million.

In addition, Justice Kennedy advanced the idea that “a business may be present in a state in a meaningful way without that presence being physical in the traditional sense of the term.” He concluded that “(g)iven these changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill,” which harms states more than was anticipated.

The case now returns to the circuit court for a decision on the merits.

States attempt to combat tax fraud using paper checks for some refunds

Lately, much has been made of the increasingly creative and pervasive tax fraud schemes. To combat them, state and federal governments have deployed a plethora of tactics, as we explained last month.

Now, some states are going one step further by reverting to a particularly old-school method: using paper checks for issuing refunds.

South Carolina

Last week, the South Carolina Department of Revenue (SCDOR) announced its implementation of “enhanced [security] measures, including the conversion of some direct deposit refunds to paper checks,” beginning in early March.

Despite requesting a direct deposit for a refund, some will receive paper checks, which may be slightly delayed. For these taxpayers, the SCDOR determined that the refund was “part of a targeted group flagged as containing potentially fraudulent refunds.” Even so, the receipt of a paper check does not mean that the taxpayer’s personal information has been compromised; it is a precautionary measure.

However, the SCDOR warns, if one receives a paper check as a refund but has not yet filed a return, one should not cash the check; and call the SCDOR as soon as possible.

The SCDOR concedes that criminals’ attempts to steal taxpayer refunds are a growing problem, but emphasized that it is committed to fighting it. The announcement provided reassurances that its systems have not been compromised, and that protecting taxpayer information remains its top priority.

Colorado

The Centennial State is undertaking the same precautions. While closely monitoring income tax filings, the Colorado Department of Revenue (CDOR) may issue refunds via paper checks instead of directly depositing them. Such action is “intended to prevent criminals from easily diverting fraudulent refunds to their own prepaid, reloadable cards or debit cards.”

The CDOR directs taxpayers to its website to verify the status of their returns.

Connecticut, Alabama, and Utah

Bloomberg.com reported that Connecticut, Utah, and Alabama will also be issuing refunds in the form of paper checks.

In Connecticut, all first-time filers and all refunds flagged as potentially suspicious will get paper checks.

In Utah, Bloomberg noted that the increase in paper checks is dramatic, because requests for refunds on certain types of debit cards are all being issued via checks.

And like some other states, the Alabama Department of Revenue is implementing an identity theft quiz to help detect suspected fraud. It is also converting refunds claimed by all first-time filers to paper checks instead of direct-depositing the refunds.

A nationwide problem

Bloomberg quoted Verenda Smith, deputy director at the Federation of Tax Administrators, as acknowledging that these states are the tip of the iceberg. She concedes that receiving paper checks is a minor inconvenience to taxpayers, but is also very helpful in stopping fraud.

A WLTX report revealed that there has been a 3,700 percent increase in fraudulent tax filings this year in some states. Nationally, the Internal Revenue Service identified 85,385 fraudulent federal tax returns involving identity theft in 2013. In 2014, that number fell to 28,076.

The report described the typical tax fraud case, in which thieves steal personal information and then use that information for nefarious purposes—they file bogus returns requesting that the refunds be sent to the thieves at a mail drop or an online banking account through direct deposit.

For additional information regarding these subjects, or any other multistate tax issues, please contact:

David M. Kall
216.348.5812
dkall@mcdonaldhopkins.com

David H. Godenswager, II
216.348.5444
dgodenswager@mcdonaldhopkins.com

Susan Millradt McGlone
216.430.2022
smcglone@mcdonaldhopkins.com

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