CRS REPORT STUDIES STATE TAX ON RETIREMENT BENEFITS.

                           Marie B. Morris

Nevada and Florida have enacted legislation which exempts from enforcement of judgments all property within the state of a judgment debtor where the judgment is in favor of any state for failure to pay that state's income taxes on retirement benefits. While this type of legislation may raise questions of constitutionality under the full faith and credit clause of the Constitution, at present, states with "source taxes" on retirement income are not necessarily pursuing collections through judgments, which lessens the probability that this type of legislation will be challenged in the near future.

BACKGROUND

A number of states impose income taxes on all income earned in the state. Carried to its logical end, this means a taxpayer owes income taxes on retirement income which was earned in that state even after the retiree has moved to another state. ¹ It comes as a shock to retirees who have left the state where they were employed to retire to a state with no income taxes when they receive a notice in the mail that their former state of residence expects them to continue paying income taxes as long as they continue to receive retirement income. The state income tax on nonresidents' pensions has come to be referred to as the "source tax" because the state where the pension was earned, the "source state," imposes the tax on the nonresidents' retirement income. In response to residents' anger over the perceived tax grab, Nevada and Florida have adopted protective legislation. The Nevada law exempts from execution

All property in this state of the judgment debtor where the judgment is in favor of any state for failure to pay that state's income tax on benefits received from a pension or other retirement plan. Nevada Rev. Stat. Ann. Section 21.090.

The Florida law declares

All property in this state of a judgment debtor where the judgment is in favor of any state for failure to pay that state's income tax on benefits received from a pension or other retirement plan is exempt from forced sale under process of any court, and no such judgment or execution based thereon shall be a lien on such property. Florida Stats. Ann. Section 55.146.

Similar legislation has been introduced in other states as well.

Protective legislation of this type, which essentially closes the courts to collection of source taxes, raises questions under the full faith and credit clause of the Constitution. This report discusses those issues.

ANALYSIS

Article IV, section 1, of the Constitution requires full faith and credit to be given in each state to the public acts, records, and judicial proceedings of every other state. It permits Congress to enact laws prescribing the manner in which such, acts, records, and proceedings shall be proved, and the effect of doing so. The full faith and credit clause is sometimes invoked in choice of law questions and sometimes invoked when a judgment granted in one state is brought to a second state for enforcement. This paper's discussion limits itself to the question of enforcement of judgments obtained in a foreign state and assumes that any judgment obtained for income taxes owing on a pension earned by a nonresident would be validly obtained in the state imposing the tax.

Although the full faith and credit clause can encompass many issues, several points have been become clear. First, an action to enforce a judgment is different from the action on which the judgment was entered. In an action on the judgment, the validity of the underlying claim is not open for reexamination. As the Supreme Court stated in McElmoyle v. Cohen, 38 U.S. 311, 324 (1839), the full faith and credit clause,

"as it relates to judgments, was intended to provide the means of giving to them the conclusiveness of judgments upon the merits, when it is sought to carry them into judgments by suits in the tribunals of another state."

Second, although the judgment is a record which is not examinable upon the merits, the judgment is not automatically enforceable in the sister state. To have the force of a judgment in the sister state,"it must be made a judgment there; and can only be executed in the latter as its laws may permit." Id.

Third, the forum state is entitled to apply its procedural laws to the enforcement of the foreign judgment. In upholding the application of a shorter statute of limitations to foreign judgments than the local judgments, the Court stated

"there is no direct constitutional inhibition upon the states, nor any clause in the constitution from which it can be even plausibly inferred, that the states may not legislate upon the remedy in suits upon the judgments of other states, exclusive of all interference with their merits." 38 U.S. at 327.

The case upheld the application of a five-year statute of limitations on foreign judgments in Georgia, even though the Georgia rule for domestic judgments and South Carolina, where the original judgment was entered, had substantially longer periods of limitations. McElmoyle was decided before the equal protection clause was added to the Constitution, but in a similar case decided in 1966, the Supreme Court reached a similar result.

Watkins v. Conway, 385 U.S. 188 (1966), upheld a Georgia statute requiring suits on foreign judgments to be brought within five years of obtaining the judgment. This period was shorter than the rule for domestic judgments and shorter than the limitation period where the original judgment was obtained. The judgment creditor brought suit in Georgia five years and one day after obtaining the Florida judgment. The Georgia court gave summary judgment for the debtor. The judgment creditor challenged the Georgia statute's discrimination based on the full faith and credit clause and the equal protection clause. The Supreme Court ruled that the Georgia statute did not discriminate against this foreign judgment since the judgment creditor could return to Florida, revive his judgment, and then sue on the revived judgment within five years.

Fourth, the forum state cannot use procedural or jurisdictional statutes to escape their obligations under the full faith and credit clause. The Court has prohibited states from denying jurisdiction to courts that would otherwise be competent in order to escape their constitutional obligations under the full faith and credit clause. In Kenney v. Supreme Lodge, 252 U.S. 411 (1920), the Court held unconstitutional an Illinois ruling refusing to enforce an Alabama judgment for wrongful death which occurred in Alabama. Because an Illinois statute provided that no action should be brought or prosecuted in Illinois for damages occasioned by death occurring in another state in consequence of wrongful conduct, the Illinois courts refused to enforce the Alabama judgment on the grounds that they could not enforce a judgment if the underlying case could not have been brought in the state. The Supreme Court overruled the Illinois courts, saying that the fact that the original cause of action could not have been maintained in Illinois was not an answer to a suit upon a judgment. A state cannot escape its constitutional obligations by the simple device of denying jurisdiction to courts otherwise competent.

In Broderick v. Rosner, 294 U.S. 629 (1935), the Superintendent of Banks in New York State brought an action in New Jersey to enforce unpaid assessments against 557 New Jersey shareholders in a New York bank. New Jersey had a statute which provided that no action could be maintained in its courts to enforce a shareholder's statutory personal liability arising under the laws of another state, unless the suit was brought in equity and all shareholders and all creditors were joined as necessary parties. The bank had more than 20,000 shareholders and more than 400,000 depositors, many of whom did not live in New Jersey. Joining all those parties would cost more than the Superintendent was seeking to collect. New Jersey dismissed the suit for failure to file in equity. The Court ruled that although the assessment was statutory, the full faith and credit clause applied, and that since the New Jersey courts possessed general jurisdiction over the subject matter and the parties, the full faith and credit clause required that the suit be entertained.

There are a few defenses to a suit on a judgment: lack of jurisdiction of the original court rendering the judgment and satisfaction or payment of the judgment. Milwaukee County v. White Co., 296 U.S. 268, 275 (1935).

In numerous cases this Court has held that credit must be given to the judgment of another state although the forum would not be required to entertain the suit on which the judgment was founded; that considerations of policy of the forum which would defeat a suit upon the original cause of action are not involved in a suit upon the judgment and are insufficient to defeat it. Id. at 277.

Milwaukee County v. White Co. holds that a judgment cannot be denied full faith and credit merely because it is for taxes. If a state were to bring a judgment for taxes on retirement benefits to Nevada or Florida, under the full faith and credit clause the Nevada and Florida courts would be required to entertain the action on the judgment. However, their laws prohibit enforcement of the judgment. Neither Florida nor Nevada has a state income tax, and apparently both states have a policy against any state imposing taxes on its citizens' retirement incomes. Are these laws constitutional under the full faith and credit clause?

The Nevada and Florida statutes only purport to list certain property exempt from judicially enforced execution. Although McElmoyle contains language which suggests that a judgment can only be enforced as the laws of the state into which the judgment is brought permit, it seems contrary to the spirit of the full faith and credit clause to provide no remedy. This would not be a case where the statute of limitations is shortened; nor would it be a case where the taxing state had to go through procedural hurdles; under these statutes the taxing state could not use the power of the sister state's courts to collect against any property of the debtor. Although the statutes purport to relate only to the remedy, these statutes seem to close the courts of the state to the judgment creditor as effectively as if the courts refused to entertain the suit.

Although we have been unable to find authority for the proposition that a sister state must provide some sort of remedy, Broderick v. Rosner and Kenney v. Supreme Lodge may suggest that if a statute such as those in Nevada and Florida were subject to constitutional challenge, there is a possibility that it would be found unconstitutional under the full faith and credit clause.

It may be unlikely that these statutes would be challenged in the near future. California is one of the states associated with efforts to collect income taxes on nonresidents' pension income earned in California. In telephone conversations with attorneys in the Legal Division of the California Franchise Tax Board, we learned that the California collection efforts work something like this.

California learns of nonresidents who are receiving California- source pensions from reporting that is required of retirement plans. Of course, they have the most information on plans covering retired state employees. Computer checks indicate which retirees have not filed returns. Those people are sent letters informing them of their California tax obligations and requesting them to file a return. If a return is not filed, California makes a determination about the amount owed and assesses that amount against the retiree. Our sources indicated that the assessment often brings a response because California's assessment may be higher than the amount which would ultimately be owed if the person filed a return. (The assessment may not account for marital status or dependents, for example.)

If the assessment is not paid or responded to in some way, California turns the matter over to bill collector's in the state where the retiree resides. They attempt to collect the bill in much the same way that a credit card debt is collected. If the bill is still not paid, the department may notify credit reporting agencies of the outstanding obligation. This may cause taxpayers to settle with California when they desire new extensions of credit. If the nonpayer is a former state employee, the state also has the option of withholding the taxes from the employee's annuity.

Because of the small amounts of tax involved, our sources indicated that it was unlikely that the tax assessment would be reduced to a judgment or pursued in the courts of a neighboring state. Thus, the Nevada and Florida statutes were not seen as a bar to collecting the taxes on nonresidents' retirement incomes. Perhaps only the out-of-state collection agencies would encounter this obstacle.