My September 2007 issue of TAX HOTLINE got buried in a pile and I just found it. The lead item under Tax News on Page 1 concerns a tax case that the US Supreme Court has agreed to hear in its 2007-2008 term, which just began.
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The Internal Revenue Code exempts from federal income tax the interest earned on state or local municipal bonds, and on dividend distributions that constitute interest from a mutual fund’s investment in state and local municipal bonds. However Kentucky law, like that of most states, requires that interest income earned on bonds issued by other states be included in an individual's taxable gross income for state income tax purposes. If you own a bond issued by a Kentucky municipality the interest is exempt from Kentucky state income tax. But interest on bonds issued by New York State is fully taxed by on the Kentucky Form 740. I don’t think I ever prepared a Kentucky state income tax return.
The Internal Revenue Code exempts from federal income tax the interest earned on state or local municipal bonds, and on dividend distributions that constitute interest from a mutual fund’s investment in state and local municipal bonds. However Kentucky law, like that of most states, requires that interest income earned on bonds issued by other states be included in an individual's taxable gross income for state income tax purposes. If you own a bond issued by a Kentucky municipality the interest is exempt from Kentucky state income tax. But interest on bonds issued by New York State is fully taxed by on the Kentucky Form 740. I don’t think I ever prepared a Kentucky state income tax return.
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George and Catherine Davis filed a class action complaint arguing that Kentucky's policy of taxing out-of-state bonds was in violation of the dormant Commerce Clause - the doctrine that the Commerce Clause forbids states from interfering with interstate commerce. The state trial court ruled in favor of the Kentucky Department of Revenue and declared the tax policy constitutional. However, The Kentucky Court of Appeals reversed the lower court and struck down the tax policy. It held that the tax discrimination rather than the bond issuance was at issue, and the taxation was indisputably undertaken in the state's capacity as a regulator. The court concluded that the Commerce Clause was incompatible with such a discriminatory state policy.
George and Catherine Davis filed a class action complaint arguing that Kentucky's policy of taxing out-of-state bonds was in violation of the dormant Commerce Clause - the doctrine that the Commerce Clause forbids states from interfering with interstate commerce. The state trial court ruled in favor of the Kentucky Department of Revenue and declared the tax policy constitutional. However, The Kentucky Court of Appeals reversed the lower court and struck down the tax policy. It held that the tax discrimination rather than the bond issuance was at issue, and the taxation was indisputably undertaken in the state's capacity as a regulator. The court concluded that the Commerce Clause was incompatible with such a discriminatory state policy.
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TAX HOTLINE points out that if the decision is upheld by the Supreme Court than “the majority of states, including California and New York {and New Jersey – rdf} would have to exempt all municipal bond interest, regardless of where the bonds were issued, or tax them all.”
TAX HOTLINE points out that if the decision is upheld by the Supreme Court than “the majority of states, including California and New York {and New Jersey – rdf} would have to exempt all municipal bond interest, regardless of where the bonds were issued, or tax them all.”
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The item ends by raising the possibility that the states may have to issue refunds on previously taxed out-of-state bond interest for all “open” years.
The item ends by raising the possibility that the states may have to issue refunds on previously taxed out-of-state bond interest for all “open” years.
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Let us keep our fingers crossed that the Supreme Court rules all municipal bond interest must be treated equally by the states. It means refunds for my clients and billable hours for me!
Let us keep our fingers crossed that the Supreme Court rules all municipal bond interest must be treated equally by the states. It means refunds for my clients and billable hours for me!
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I will let you know what happens.
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TTFN
TTFN
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