       Whether Missouri Municipalities May Tax the Portion of
          Federal Salaries Voluntarily Contributed to the
                        Thrift Savings Plan


Intergovernm ental tax im m unity does not p reclu d e m unicipalities in M issouri from levying an earnings
    tax on the voluntary contributions of federal em ployees to the T hrift Savings Plan.


                                                                                                      N o v e m b e r 10, 1993



                            M e m o r a n d u m O p in io n f o r t h e G e n e r a l C o u n s e l
                                          D e p a r t m e n t o f A g r ic u l t u r e


    Y o u have requested our opinion on the following question: Must the National
Finance Center (“NFC”) o f the Department of Agriculture (“USDA”) withhold and
remit local earnings taxes levied by the municipalities of St. Louis and Kansas
City, Missouri, upon that portion o f federal employees’ salaries voluntarily con­
tributed to the Thrift Savings Plan (“TSP”)?1 The Financial Management Service
(“FMS”) of the Department of the Treasury (“Treasury”) has taken the position
that NFC should not withhold the Kansas City earnings taxes on TSP contributions
of FMS employees because similar payments made by municipal employees are
not subject to the earnings tax.2 As we explain in further detail below, we disagree
with this approach because TSP contributions, which are held in trust for the con­
tributors, can be distinguished from the deferred compensation plan payments that
are exempt — by a court ruling — from earnings taxes. Thus, intergovernmental
tax immunity does not preclude the Missouri municipalities from levying an earn­
ings tax on voluntary TSP contributions. The St. Louis and Kansas City earnings
taxes should be withheld and remitted.

                                                              I.

   The Thrift Savings Plan, 5 U.S.C. §§ 8431-8440d, which was established as
part of the Federal Employees’ Retirement System (“FERS”), 5 U.S.C. §§ 8401-
8479, enables each federal employee covered by FERS to elect to contribute, in
any pay period, as much as ten percent of the employee’s “basic pay” to the em­
ployee’s TSP retirement account. 5 U.S.C. § 8432(a). All TSP contributions are


     1 L etter for D aniel K offsky, Acting A ssista n t A ttorney G en eral, O ffice o f Legal C ounsel, from Jam es S
G illila n d , G en eral C ounsel, Department o f A g ricu ltu re (Ju ly 12, 1993).
     2 N eith er FM S n or any o th e r unit of T rea su ry has su b m itted a b rie f in response to the U SD A request, but
the p o sitio n o f T reasu ry is set forth in a m em o ran d u m w ritten by A ttom ey-A dvisor Elton A E llison o f the
O ffice o f C h ie f C o u n sel d a te d M ay I, 1990, an d a letter d rafted by A ssistant C om m issioner B land T. B rock-
e n b o ro u g h d ated January 2, 1992

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channeled into a Thrift Savings Fund in the Treasury of the United States.3 Id.
§ 8437(b). These contributions are then held in the Fund in trust for the employees
who made the contributions. Id. § 8437(g). By law, the Thrift Savings Fund is
“treated as a trust described in section 401(a) of [the Internal Revenue] Code
which is exempt from taxation under section 501(a) of such Code,” id.
§ 8440(a)(1), and contributions to the Thrift Savings Fund are “treated in the same
manner as contributions to” such a trust. Id. § 8440(a)(2).

                                                      II.

   Two cities in Missouri — St. Louis and Kansas City — have adopted ordi­
nances that impose a tax on salaries, wages, and other compensation earned or re­
ceived by city residents and nonresidents who work in the cities. Kansas City,
Mo., Code 32.141(a)(1) & (2); St. Louis, Mo., Code § 5.22.020(A) & (B). Kansas
City imposes “a one per centum (1 .0%) per annum” municipal tax:

(1)     On all salaries, wages, commissions and other compensation earned
        or received by resident individuals of the city for work done or services per­
        formed or rendered.

(2)     On all salaries, wages, commissions and other compensation earned or re­
        ceived by nonresident individuals of the city for work done or services per­
        formed or rendered in the city.

Kansas City, Mo., Code § 32.141(a). Similarly, St. Louis imposes an earnings tax
“for general revenue purposes of one percent” on all “salaries, wages, commissions
and other compensation” earned by its residents and by nonresidents for “work
done or services performed” in the city. St. Louis, Mo., Code § 5.22.020(A) & (B).
    In 1989, however, the Missouri Court of Appeals determined that the City of
Kansas City could not levy its municipal earnings tax upon sums paid at the direc­
tion of an employee of the Board of Police Commissioners to the Kansas City Po­
lice Department Deferred Compensation Plan. Whipple v. City o f Kansas City, 779
S.W.2d 610 (Mo. Ct. App. 1989). The Whipple court reasoned that, because all
sums paid to the Deferred Compensation Plan were exchanged for nothing more
than “the unsecured promise of the board to pay the employee whatever balance
may be in the account at the employee’s retirement or separation from the depart­
ment,” id. at 611, such sums were not subject to the municipal earnings tax. Id. at
613-14. As the court explained: “The city’s position that it may extract a tax from
employees based on sums they have not received and may never receive is simply
untenable.” Id. at 614.

   3    The T h rift Savings Fund also co n tain s other assets such as contributions m ade by governm ent agencies
that em ploy the federal w orkers w ho participate in the T S P 5 U S C § 8437(b), see also id. § 8479(b)

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   The Whipple court, of course, did not address the validity of municipal earnings
taxes imposed upon federal employees who partake of the TSP program. Never­
theless, as your letter points out, under the Supreme Court’s ruling in Davis v.
Michigan Department o f the Treasury, 489 U.S. 803 (1989), neither states nor
municipalities may differentiate between similarly situated federal employees and
state or municipal employees in levying state and local taxes. This restriction
flows from the constitutional principle of intergovernmental tax immunity and 4
U.S.C. §111, which states:

       The United States consents to the taxation of pay or compensation
       for personal service as an officer or employee of the United States
       . . . by a duly constituted taxing authority having jurisdiction, if the
       taxation does not discriminate against the officer or employee be­
       cause o f the source o f the p a y or compensation.

4 U.S.C. § 111 (emphasis added). Interpreting this provision in conjunction with
the constitutional conception of intergovernmental tax immunity, see Davis, 489
U.S. at 813 (characterizing § 111 and modern constitutional doctrine as
“coextensive”), the Supreme Court concluded that intergovernmental tax immunity
precludes taxation of federal employees “to the extent that such taxation discrimi­
nates on account of the source of the compensation.” Id. at 810. Applying this
rule, the Court held that the State of Michigan could not levy an income tax on
retirement benefits paid by the federal government while exempting from taxation
retirement benefits paid by the state or its political subdivisions. Id. at 814-17.
Simply put, the Michigan taxation scheme failed because the inconsistent treatment
of state and federal employees was not “directly related to, and justified by,
‘significant differences between the two classes.’” Id. at 816 (quoting Phillips
Chem. Co. v. Dumas Indep. Sch. D ist., 361 U.S. 376, 383 (I960)).
    The Supreme Court applied this understanding of the rule of intergovernmental
tax immunity in Barker v. Kansas, 503 U.S. 594 (1992), where the Court struck
down a Kansas scheme that levied taxes on the benefits paid to military retirees but
exempted benefits received by retired state and local government employees.
Again, the Court emphasized that it “evaluate[s] a state tax that is alleged to dis­
criminate against federal employees in favor of state employees by inquiring
‘whether the inconsistent tax treatment is directly related to, and justified by,
“significant differences between the two classes.’” ” Id. at 598 (quoting Davis, 489
U.S. at 816) (quoting Philips Chem., 361 U.S. at 383). Not surprisingly, the Court
invalidated the Kansas taxation scheme by applying this basic principle. Id. at
598-605.




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                                             III.

   The issue raised by your inquiry must be resolved through the application of the
principle set forth in Davis and Barker. By judicial decision, the sums paid to the
Missouri Police Department Deferred Compensation Fund are exempt from the
Kansas City earnings tax. See Whipple, 779 S.W2d 610 (Mo. Ct. App. 1989). In
contrast, the voluntary TSP contributions of federal employees historically have
been subject to the Kansas City earnings tax. The validity of the taxation of vol­
untary TSP contributions turns on “whether the inconsistent tax treatment is di­
rectly related to, and justified by, ‘significant differences between the two
classes.’” Davis, 489 U.S. at 816 (quoting Philips Chem., 361 U.S. at 383); a c­
cord Barker, 503 U.S. at 598. We believe that a significant difference between
voluntary TSP contributions and sums paid to the Missouri Police Department De­
ferred Compensation Fund justifies the existing disparity in tax treatment.
   Voluntary TSP contributions are held in trust for the benefit of the employees
who participate in the plan. See 5 U.S.C. § 8437(g). The legal nature of the Thrift
Savings Fund creates a legitimate and enforceable expectation of the return of
contributions to TSP participants. Indeed, this is precisely what Congress antici­
pated. See S. Rep. No. 99-166, at 14 (1985), reprinted in 1986 U.S.C.C.A.N.
1405, 1419 (“Employees are immediately vested in their own contributions and
earnings attributable to them. . . . At retirement an employee may withdraw the
account balance either in a lump sum . . . or in installments.”); H.R. Conf. Rep. No.
99-606, at 134-135 (1986), reprinted in 1986 U.S.C.C.A.N. 1508, 1517-1518
(adopting provision for full and immediate vesting of both employer and employee
contributions, and discussing options for withdrawal of contributions).
   In comparison, the return of any sums paid to the deferred compensation plan at
issue in Whipple is essentially speculative. As the Whipple court explained:

       [A participating employee’s] account reflects the current status of
       the employee’s prospective benefits, but the account is the property
       of the board . . . . The sole interest of the employee in his deferred
       compensation is the unsecured promise of the board to pay the em­
       ployee whatever balance may be in the account at the employee’s
       retirement or separation from the department.

Whipple, 779 S.W.2d at 611. Indeed, the deferred compensation plan included
language that qualified each participant’s claim to any sums paid at a participant’s
direction to the plan:

       All amounts of Compensation deferred under this Plan, all property
       and rights which may be purchased by the Employer with such
       amounts and all income attributable to such amounts, property or

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                                      Opinions o f the O ffice o f L egal C ounsel


           rights to property shall remain the sole property and rights of the
           Employer without being restricted by the provisions of this Plan
           subject only to the claims of the Employer’s general creditors. The
           obligation of the Employer under this Plan is purely contractual and
           shall not be funded or secured in any way.

Id. Based on these provisions, the court of appeals concluded that an “employee
has no guarantee that any payment o f deferred compensation will be made.” Id. at
612.
   The provisions of the deferred compensation plan discussed in Whipple, which
significantly qualified the claims of participants to payments made at their direc­
tion, render sums paid to the plan in Whipple readily distinguishable from volun­
tary TSP contributions. Thus, Kansas City and St. Louis cannot be forbidden, by
either the constitutional principle of intergovernmental tax immunity or by 4
U.S.C. § 111, to impose a municipal earnings tax upon voluntary TSP contribu­
tions. Unless a Missouri court rules that earnings taxes cannot be levied upon vol­
untary TSP contributions as a matter of state law, the Kansas City and St. Louis
earnings taxes should be withheld and remitted for voluntary TSP contributions.4

                                                            IV.

   Your request for an opinion on the validity of earnings taxes levied by Missouri
municipalities necessitated a comparison of voluntary TSP contributions and sums
paid to a specific deferred compensation plan that are exempted, by a judicial rul­
ing, from the earnings tax. Our analysis turns upon a material distinction between
the two types of contributions. We find, based upon this material distinction, that
intergovernmental tax immunity does not foreclose the imposition of an earnings

    4      Y o u r in q u iry a ssu m es that voluntary T S P contributions “ are not included in an em p lo y ee’s gross w ages
for Federal incom e tax p u rposes ” This fact, how ever, does not affect o u r analysis o f the intergovernm ental
lax im m u n ity issue A s a g en eral matter, sta te s and m u n icip alities may tax earnings that are exem pt from
taxation u n d e r the Internal R ev en u e Code, an d the earnings tax es levied by K ansas C ity and St. Louis appar­
ently sw eep m ore bro ad ly than the federal in co m e lax law s S e e W hipple, 77 9 S W .2d at 613 n 3
     T o be sure, a T S P p artic ip a n t could ch allen g e, under M isso u n law, the application o f the earnings tax to
T S P co n trib u tio n s by filing a declaratory ju d g m e n t action in state court. Indeed, the W hipple decision
strongly su g g ests th at such an action would be successful. Id. at 613-14 & n 3. As the W hipple court o b ­
served, a M isso u ri statu te pro scrib es the tax atio n o f any p ay m en t m ade to a deferred com pensation program
“ ‘to the sam e e x ten t as it is ex em p t from in c o m e tax im posed by the U nited S t a t e s . Id. at 613 (quoting and
interp retin g M o. A nn Stat. § 105.900.2) T h is statute, w hen read in conjunction with lim itations im posed by
M issou ri law u p o n the tax in g authority o f m u n icip alities, p ro m p ted the W hipple court to opine that K ansas
C ity lack ed the cap a c ity u n d e r state law to tax such paym ents as earnings. Id. at 613-14 & n 3
     T his arg u m en t m ight w ell be persuasive m a d eclaratory ju d g m e n t action sn a M issoun court, but u is not
the p ro v in ce o f this O ffice to issue authoritative in terp retatio n s o f state law s and m unicipal codes. See
L e tte r for H on W endell H. Ford from M ary C . L aw ton ai 3 (A p r. 5, 1976) (explaining that “we o f course are
not in a p o sitio n to g iv e an authoritative in terp retatio n o f State law ”); cj. P ennhurst S ta te Sch. & H osp. v
H a ld e rm a n , 465 U S. 89, 106 (1984) (noting im propriety o f federal courts instructing stale officials “on how
to c o n fo rm th eir c o n d u ct to state law”). H ence, o ur opinion d o es not address the validity o f ihe m unicipal
earn in g s ta x e s as a m atter o f M issoun law.

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                 The N eed To W ithhold and R em it L ocal E arnings Taxes


tax by the Missouri municipalities. Therefore, we anticipate that the NFC will
withhold and remit earnings taxes for TSP contributions.


                                                    WALTER DELLINGER
                                                   Assistant Attorney General
                                                    Office o f Legal Counsel




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