The Securities and Exchange Commission

[thepennyking]

Tax Injunction Act - Federal-Court Jurisdiction Over Litigation Challenging Tax Credits. The Tax Injunction Act ("TIA") prohibits federal courts from "enjoin[ing], suspend[ing] or restrain[ing] the assessment, levy or collection of any tax under state law where a plain, speedy and efficient remedy may be had" in state court. 28 U.S.C. § 1341. The Supreme Court granted certiorari in Hibbs v. Winn, No. 02-1809, to determine whether either the TIA or the principles of federal-state comity that underlie it bar federal-court litigation challenging the constitutionality of state tax credits . in particular, an Arizona credit for contributions made to organizations that provide tuition grants to sectarian schools.

Arizona Revised Statute Section 43-1089, enacted in 1997, allows taxpayers to reduce their state tax liability by claiming a credit of up to $625 for contributions to organizations called School Tuition Organizations ("STOs"). STOs provide educational scholarships to students attending private schools. Under Arizona law, STOs are permitted to — and most STOs do — limit their grants to students attending parochial schools maintained by a single religious sect or to children of families who belong to a particular religious faith. The Arizona Supreme Court has held that the STO program does not violate the Establishment Clause. See Kotterman v. Killian, 972 P.2d 606 (Ariz.), cert. denied, 528 U.S. 921 (1999).

Plaintiffs, Arizona taxpayers, sued in federal court arguing that, despite the Arizona Supreme Court’s decision in Kotterman, the STO program constitutes an impermissible government subsidy of religious schools in violation of the Establishment Clause. The state moved to dismiss the lawsuit, arguing that, because plaintiffs challenged Arizona’s "assessment" of state income taxes, the district court lacked subject matter jurisdiction pursuant to the TIA and to underlying principles of comity. The district court agreed.

The Ninth Circuit reversed. 307 F.3d 1011 (2002). According to the court of appeals, the term "assessment" as used in the TIA means either (1) the estimation of the value of property or income as a basis for taxation, or (2) the imposition of a tax or other charge. The court concluded that neither definition covers the allowance of a tax credit, which merely affects the calculation of taxes after a taxpayer’s gross income has been determined. Id. at 1015. According to the Ninth Circuit, the TIA does not preclude lawsuits like this one, because a decision striking a tax credit would increase state revenues. Id. at 1017. The Ninth Circuit also rejected the argument that principles of comity warranted dismissing the lawsuit: "[A]n ultimate judgment on the merits for plaintiffs here — much less the conduct of this litigation — would have no effect at all on the implementation of any other Arizona tax provisions, nor would it chill the activities of Arizona tax collectors." Id. at 1019-20. The Ninth Circuit subsequently denied rehearing en banc, over a two-judge dissent. 321 F.3d 911 (2003).

Because states frequently grant tax credits to implement a wide variety of policy choices, this case is of significant interest to almost every business.