GEORGE W. DAVIS AND CATHERINE V. DAVIS v. DEPARTMENT OF REVENUE OF THE FINANCE AND ADMINISTRATION CABINET, COMMONWEALTH OF KENTUCKY (FORMERLY COMMONWEALTH OF KENTUCKY, REVENUE CABINET) AND COMMONWEALTH OF KENTUCKY FINANCE AND ADMINISTRATION CABINET
Annotate this Case
Download PDF
RENDERED:
JANUARY 6, 2006; 10:00
TO BE PUBLISHED
A.M.
Commonwealth Of Kentucky
Court of Appeals
NO. 2004-CA-001940-MR
GEORGE W. DAVIS
AND CATHERINE V. DAVIS
APPELLANTS
APPEAL FROM JEFFERSON CIRCUIT COURT
HONORABLE BARRY WILLETT, JUDGE
CIVIL ACTION NO. 03-CI-003282
v.
DEPARTMENT OF REVENUE OF THE
FINANCE AND ADMINISTRATION CABINET,
COMMONWEALTH OF KENTUCKY (FORMERLY
COMMONWEALTH OF KENTUCKY, REVENUE CABINET)
AND COMMONWEALTH OF KENTUCKY
FINANCE AND ADMINISTRATION CABINET
APPELLEES
OPINION
VACATING AND REMANDING
** ** ** ** **
BEFORE:
BARBER, MINTON, AND TAYLOR, JUDGES.
MINTON, JUDGE:
I.
INTRODUCTION.
George and Catherine Davis appeal from the Jefferson
Circuit Court’s grant of summary judgment in favor of the
Department of Revenue of the Finance and Administration Cabinet
for the Commonwealth of Kentucky (“the Department”).
Because we
find that Kentucky’s tax on the income derived from bonds issued
outside Kentucky violates the Commerce Clause of the United
States Constitution, we vacate and remand.
II.
FACTUAL BACKGROUND AND PROCEDURAL HISTORY.
Although the legal theories involved are quite
complex, 1 the pertinent facts of this case are simple.
Kentucky
Revised Statute (KRS) 141.020 governs individual state income
taxes.
Similar provisions exist for the Commonwealth to tax
estates, trusts, and fiduciaries, 2 as well as corporations. 3
KRS 141.020 requires an individual to pay state taxes upon a
percentage of that person’s net income. 4
For individuals, net
income is determined by making certain deductions from the
individual’s adjusted gross income. 5
In turn, an individual’s
adjusted gross income is derived by making certain deductions
1
Indeed, even the United States Supreme Court once declared its own
jurisprudence involving the dormant Commerce Clause to be a
“quagmire” which left “much room for controversy and confusion and
little in the way of precise guides to the States in the exercise of
their indispensable power of taxation.” Northwestern States
Portland Cement Co. v. State of Minn., 358 U.S. 450, 457-458 (1959).
2
KRS 141.030.
3
KRS 141.040.
4
KRS 141.020(1); KRS 141.030(1); KRS 141.040(1).
5
KRS 141.010(11) provides that “‘[n]et income’ in the case of
taxpayers other than corporations means adjusted gross income as
defined in subsection (10) of this section, minus the standard
deduction allowed by KRS 141.081, or, at the option of the taxpayer,
minus the deduction allowed by KRS 141.0202 . . . .”
-2-
from a person’s gross income “as defined in Section 61 of the
Internal Revenue Code.” 6
In arriving at its definition of gross
income, the Internal Revenue Code specifically exempts interest
earned on any state or local bond. 7
But Kentucky law requires
that “interest income derived from obligations of sister states
and political subdivisions thereof” is to be included in a
person’s adjusted gross income. 8
The cumulative impact of those
various statutes is that Kentucky exempts from taxation interest
income derived from bonds issued by the Commonwealth of Kentucky
or its subdivisions but requires taxes to be paid on interest
income derived from bonds issued by a sister state or its
subdivisions.
In April 2003, the Davises filed a class action
declaratory judgment complaint alleging that Kentucky’s decision
to tax the income earned on out-of-state bonds in this manner
violates the Commerce Clause of the United States Constitution
and the Equal Protection Clause of the Fourteenth Amendment to
the United States Constitution.
To attempt to demonstrate
standing, the Davises alleged in their complaint that they were
6
KRS 141.010(9),(10). Section 61 of the Internal Revenue Code is
codified at 26 U.S.C. § 61.
7
26 U.S.C. § 103 provides that “gross income does not include
interest on any State or local bond.”
8
KRS 141.010(10)(c). Similarly, “interest income derived from
obligations of sister states and political subdivisions thereof” is
included in a corporation’s gross income. KRS 141.010(12)(c).
-3-
residents of Jefferson County who had paid Kentucky income tax
on the income they earned from out-of-state bonds.
In July 2003, before the Davises had filed a motion
for class certification, the Department filed a motion for
summary judgment arguing that the tax system in issue was
constitutional and that, furthermore, the Davises lacked
standing to challenge the tax provisions applicable to
corporations, estates, and trusts.
In August 2004, the
Jefferson Circuit Court granted the Department’s motion for
summary judgment on both the constitutionality of the bond
taxation system and the question of the Davises’ standing.
The
Davises filed this appeal.
III.
ANALYSIS.
The Davises’ appeal presents two issues.
First, did
the trial court correctly grant summary judgment to the
Department on the Davises’ claim that Kentucky’s system of
taxing only out-of-state bonds is unconstitutional?
Second, did
the trial court correctly find that the Davises lacked standing
to assert claims on behalf of corporations, trusts, estates, and
all other non-individual plaintiffs?
Following a recitation of
the applicable standards of review, each question will be
addressed separately.
-4-
A.
Standard of Review.
Summary judgment is appropriate only if the Department
showed that the Davises “could not prevail under any
circumstances.” 9
In ruling on a motion for summary judgment, we
must view the evidence in the light most favorable to the
Davises. 10
An appellate court reviewing a grant of summary
judgment must determine whether the trial court correctly found
that there were no genuine issues of material fact. 11
As
findings of fact are not at issue, the trial court’s decision is
entitled to no deference. 12
B.
Constitutionality of Kentucky’s Taxation System.
“The test of the constitutionality of a statute is
whether it is unreasonable or arbitrary.” 13
A statute is
constitutionally valid “if a reasonable, legitimate public
purpose for it exists, whether or not we agree with its ‘wisdom
or expediency.’" 14
The Davises’ burden is heavy as “[a] strong
9
Steelvest, Inc. v. Scansteel Service Center, Inc., 807 S.W.2d 476,
480 (Ky. 1991) (citing Paintsville Hosp. Co. v. Rose, 683 S.W.2d 255
(Ky. 1985)).
10
Id.
11
Scifres v. Kraft, 916 S.W.2d 779, 781 (Ky.App. 1996).
12
Id.
13
Buford v. Commonwealth, 942 S.W.2d 909, 911 (Ky.App. 1997).
14
Id. (quoting Walters v. Bindner, 435 S.W.2d 464, 467 (Ky. 1968).
-5-
presumption exists in favor of the constitutionality of a
statute.” 15
Bearing those principles in mind, we now turn our
attention to the Davises’ contention that Kentucky’s system of
taxing only extraterritorial bonds violates the Commerce Clause
of the United States Constitution. 16
This issue is a matter of
first impression in Kentucky. 17
The Commerce Clause simply provides that Congress has
the power to “regulate Commerce with foreign Nations, and among
the several States[.]” 18
But despite the fact that the Commerce
Clause “is phrased merely as a grant of authority to Congress to
15
Id.
16
We note that we have the authority to resolve this dispute even
though it revolves entirely around interpreting the United States
Constitution. See Boston Stock Exchange v. State Tax Commission,
429 U.S. 318, 320-321 (1977) (“We agree, of course, that state
courts of general jurisdiction have the power to decide cases
involving federal constitutional rights where, as here, neither the
Constitution nor statute withdraws such jurisdiction.”)
17
Both the Davises and the Department cite other cases in support of
their positions. However, with the exception of a case from Ohio
(which will be discussed at length infra), none of the cited cases
are of much significance or help because they are not factually nor
legally on all fours with this action. See, e.g., Scott K. Attaway,
Note, The Case for Constitutional Discrimination in Taxation of Outof-State Municipal Bonds, 76 B.U. L. Rev. 737, 769 (1996) (“State
tax exemption of income earned by residents in transacting with the
state does not fall neatly within any of the Supreme Court’s
established Commerce Clause doctrines.”). Therefore, we will not
belabor this opinion by specifically distinguishing each case cited
to us as the statement of points and authorities in the parties’
briefs total thirteen pages.
18
U.S. Const., Art. I, § 8, cl. 3.
-6-
‘regulate Commerce . . . among the several States,’ Art. I, § 8,
cl. 3, it is well established that the Clause also embodies a
negative command forbidding the States to discriminate against
interstate trade.” 19
This “negative” or dormant aspect of the
Commerce clause “prohibits economic protectionism⎯that is,
regulatory measures designed to benefit in-state economic
interests by burdening out-of-state competitors.” 20
Thus, the
“fundamental command” 21 of the Commerce Clause is that “a State
may not tax a transaction or incident more heavily when it
crosses state lines than when it occurs entirely within the
State.” 22
As a result, “[s]tate laws discriminating against
interstate commerce on their face are ‘virtually per se
invalid.’” 23
Clearly, Kentucky’s bond taxation system is facially
unconstitutional as it obviously affords more favorable taxation
treatment to in-state bonds than it does to extraterritorially
issued bonds. 24
Thus, Kentucky’s bond taxation system may be
19
Associated Industries of Missouri v. Lohman, 511 U.S. 641, 646
(1994).
20
New Energy Co. of Indiana v. Limbach, 486 U.S. 269, 273 (1988).
21
Lohman, 511 U.S. at 647.
22
Armco Inc. v. Hardesty, 467 U.S. 638, 642 (1984).
23
Fulton Corp. v. Faulkner, 516 U.S. 325, 331 (1996).
Even an author who believes that the separate tax status of in-state
and out-of-state bonds should be constitutionally permissible agrees
that a bond taxation system like Kentucky’s is facially
24
-7-
found to be constitutionally valid only if it falls within an
exception to the normal rule requiring laws that violate the
Commerce Clause on their face to be stricken. 25
So we must
evaluate the Department’s three main arguments in support of
Kentucky’s taxation system to determine if the Department has
met its burden to show that the taxation system in question is
constitutionally permissible. 26
First, one of the Department’s main arguments in favor
of Kentucky’s taxation system is the fact that a similar system
has been held to be constitutionally permissible in Ohio.
In
fact, despite the discriminatory bond taxing system’s widespread
unconstitutional. See Attaway, 76 B.U. L. Rev. at 739 (1996) (“If
subjected to traditional Commerce Clause scrutiny, such
discriminatory tax treatment [of bonds] would surely fall under a
‘virtually per se rule of invalidity.’”) (quoting Philadelphia v.
New Jersey, 437 U.S. 617, 624 (1978)).
25
Limbach, 486 U.S. at 274 (“Thus, state statutes that clearly
discriminate against interstate commerce are routinely struck down,
unless the discrimination is demonstrably justified by a valid
factor unrelated to economic protectionism.”) (internal citations
omitted).
26
C & A Carbone, Inc. v. Town of Clarkstown, N.Y., 511 U.S. 383, 392
(1994) (“Discrimination against interstate commerce in favor of
local business or investment is per se invalid, save in a narrow
class of cases in which the municipality can demonstrate, under
rigorous scrutiny, that it has no other means to advance a
legitimate local interest.”). See also Hughes v. Oklahoma, 441 U.S.
322, 337 (1979) (holding that the Court would apply the “strictest
scrutiny” to determine if a statute which violates the Commerce
Clause on its face was, nevertheless, permissible based upon the
State’s arguments); Limbach, 486 U.S. at 278-279 (discussing the
state’s high burden in showing that a statute which violates the
Commerce Clause on its face is not invalid because there was no
reasonable nondiscriminatory alternative).
-8-
use and obvious Commerce Clause implications, 27 apparently, only
the Ohio courts have been presented with a case challenging it
on Commerce Clause grounds. 28
The Ohio Court of Appeals
ultimately concluded in Shaper that the bond taxation system was
constitutionally permissible.
analyze the issue.
But that court failed fully to
Shaper, though containing a well-written
preliminary analysis of the Commerce Clause implications of this
discriminatory bond taxing system, “made no attempt to explain
why . . . a tax exemption that discriminates against income
earned from out-of-state bonds . . . is permissible under the
Commerce Clause.” 29
Rather, the Shaper court “tersely stat[ed],
in effect, that ‘we looked and did not find anything so
therefore it must be constitutional.’” 30
Logic dictates,
however, that a potentially problematic and constitutionally
infirm statute does not become permissible simply because it has
not been previously found to be unconstitutional.
Rather, a
27
At the time Mr. Attaway’s law review note was published, at least
thirty-seven states had bond taxation systems similar to Kentucky’s.
See 76 B.U. L. Rev. at 738.
28
Shaper v. Tracy, 647 N.E.2d 550 (Ohio Ct. App. 1994).
29
76 B.U. L. Rev. 738, n.6.
30
Id. Mr. Attaway’s critique of Shaper is correct because the Shaper
court, after examining various theories and inapplicable cases,
simply stated its conclusion as follows: “Given the lack of any
precedent to apply the Commerce Clause to this type of taxation
scheme, we are unable to find R.C. 5747.01 [the Ohio statute in
question] unconstitutional as violative of the Commerce Clause.”
Shaper, 647 N.E.2d at 553-554.
-9-
court faced with a direct constitutional challenge to a statute
must engage in a searching inquiry to determine whether a
challenged statute can pass constitutional muster. 31
Thus,
Shaper, though instructive in certain areas, is, in and of
itself, insufficient to support the Department’s position,
meaning that we must examine the Department’s other two main
arguments.
The Department next argues that the bond taxation
system must be found to be constitutional under the Supreme
Court’s holding in Bonaparte v. Tax Court. 32
In Bonaparte, a
taxpayer contended that her state of residence was required by
the Full Faith and Credit Clause of the United States
Constitution 33 to exempt out-of-state bonds from taxation because
the issuing state exempted them.
The Supreme Court rejected the
taxpayer’s argument, holding that “no provision of the
Constitution of the United States . . . prohibit[ed] such
31
Faced with a similar Commerce Clause challenge to a Kentucky system
that taxed out-of-state bank deposits at a higher rate than in-state
deposits, the Kentucky Supreme Court opined that a court could not
shirk its duty fully to apply the law. Rather, a reviewing court
“must enforce constitutional limitations.” St. Ledger v.
Commonwealth, 912 S.W.2d 34, 39 (Ky. 1995), vacated on other grounds
by St. Ledger v. Kentucky Revenue Cabinet, 517 U.S. 1206 (1996).
32
104 U.S. 592 (1881).
33
Article IV, Section 1 of the United States Constitution provides in
relevant part that “Full Faith and Credit shall be given in each
State to the public Acts, Records, and judicial Proceedings of every
other State.”
-10-
taxation.” 34
However, Bonaparte is ultimately of little value to
the case at hand because the Commerce Clause played no role in
the Bonaparte court’s decision. 35
As the case at hand involves a
direct challenge under the dormant Commerce Clause and has
nothing to do with the Full Faith and Credit Clause, it
logically follows that Bonaparte is neither on point nor
controlling.
Finally, the Department relies upon the market
participant doctrine to save Kentucky’s bond taxation system.
The market participant theory “recognizes that when a sovereign
acts as a consumer or vendor in commerce, its actions as a
market participant are distinct from its actions as a market
regulator.
The Commerce Clause is directed at the state’s
actions as a market regulator; therefore, [a State’s] actions as
a market participant are exempted from Commerce Clause
analysis.” 36
Stated differently, the market participant theory
34
Id. at 104 U.S. 594.
35
See, e.g., Donald H. Regan, Siamese Essays: (I) CTS Corp. v.
Dynamics Corp of America and Dormant Commerce Clause Doctrine; (II)
Extraterritorial State Legislation, 85 Mich. L. Rev. 1865, 1887-1888
(1987) (“The Court in Bonaparte cites no constitutional provision in
support of its claim that states cannot legislate
extraterritorially. And quite properly not, since the
extraterritoriality principle is not to be localized in any single
clause. In particular, it is clear that the extraterritoriality
principle as it appears in Bonaparte is not based on the commerce
clause.”); Shaper, 647 N.E.2d at 765 (discussing Bonaparte’s holding
and noting that it was not based on the Commerce Clause).
36
Shaper, 647 N.E.2d at 763.
-11-
“differentiates between a State’s acting in its distinctive
governmental capacity, and a State’s acting in the more general
capacity of a market participant; only the former is subject to
the limitations of the negative Commerce Clause.
Thus, for
example, when a State chooses to manufacture and sell cement,
its business methods, including those that favor its residents,
are of no greater constitutional concern than those of a private
business.” 37
The Department’s market participant argument is
unavailing, however.
No one could seriously argue against the
principle that Kentucky acts as a market participant when it
issues bonds.
issue.
But Kentucky’s issuance of bonds is not the
Rather, the sole issue is Kentucky’s decision to tax
only extraterritorial bonds.
Thus, the market participant
theory is inapplicable as a State’s “assessment and computation
of taxes” is, clearly, “a primeval governmental activity.” 38
Accordingly, “when a state chooses to tax its citizens, it is
acting as a market regulator[,]” not as a market participant. 39
Therefore, the Department’s market participant argument is
without merit.
37
Limbach, 486 U.S. at 277 (internal citations omitted).
38
Id.
39
Shaper, 647 N.E.2d at 764.
-12-
Having found that the Department’s arguments are
unavailing, we are left with a situation in which Kentucky’s
bond taxation scheme is facially unconstitutional under the
Commerce Clause; and none of the arguments in favor of its
constitutionality offered by the Department or relied upon by
the trial court are sufficient to save it.
But under the facts
presented in this case, we have no choice but to find that
Kentucky’s system of taxing only extraterritorial bonds runs
afoul of the Commerce Clause. 40
Thus, the trial court’s decision
to grant summary judgment to the Department was erroneous. 41
B.
Standing.
The trial court found that the Davises lacked standing
to assert claims on behalf of all non-individual claimants
(i.e., corporations, trusts, estates, etc.) because they had not
shown that they had been forced to pay any taxes on extraterritorial bonds on behalf of those types of entities.
On
appeal, the Davises contend that the trial court confused the
40
As noted previously, although the cases are distinguishable,
Kentucky Courts have previously struck down legislation for
violating the Commerce Clause, such as when the Kentucky Supreme
Court struck down statutes providing for different levels of ad
valorem taxation on in-state and out-of-state bank deposits. See
St. Ledger, 912 S.W.2d 34, and St. Ledger v. Commonwealth,
942 S.W.2d 893 (Ky. 1997).
41
The trial court made no explicit findings regarding the Davises’
Equal Protection arguments. Given our Commerce Clause analysis, we
also find it unnecessary to engage in an Equal Protection analysis.
-13-
concept of standing with the somewhat related issues involved in
class certification.
We agree.
Class actions in Kentucky are governed by Rules of
Civil Procedure (CR) 23.01-23.04.
The Davises’ complaint sets
forth their intention to prosecute their claims as a class
action on behalf of all individuals, corporations, trusts,
estates, etc.
CR 23.03(1) provides that “[a]s soon as
practicable after the commencement of an action brought as a
class action, the court shall determine by order whether it is
to be so maintained.”
Thus, “[i]n a class action a plaintiff
generally files a motion seeking certification of the class even
though this is not expressly required by statute or rule.” 42
In
the case at hand, the Davises had not filed a motion for class
certification before the Department filed its motion for summary
judgment.
So any issues regarding the propriety of class
certification were not before the trial court.
Rather, the only
issues before the trial court were whether the bond taxation
system in question was constitutional and whether the Davises
had basic standing to file the action.
The question of standing only goes to whether an
individual is entitled to have his or her claims resolved by a
42
59 Am.Jur.2d Parties § 98 (2002).
-14-
court. 43
Thus, although standing is a threshold issue and a
prerequisite for all actions, in order to demonstrate standing,
a party need only show that a case or controversy exists between
that party and the defendant. 44
Only after a plaintiff has
established personal standing in a putative class action may a
court consider the separate issue of whether the plaintiff will
be able to represent the proposed class adequately under the
guidelines of CR 23.01-23.04. 45
In the case at hand, the trial court found that the
Davises had personal standing to assert claims regarding the
bond taxation issue. 46
Thus, the Davises have standing.
The
question of whether the Davises may properly represent
corporations, trusts, and estates comes into play only when the
issue of class action certification is presented.
Thus, the
portion of the trial court’s opinion finding that the Davises
lack standing is vacated.
Upon remand, the Davises will,
presumably, quickly move for class certification, at which time,
the trial court may determine all of the issues involved in
43
See, e.g., Fallick v. Nationwide Mutual Ins. Co., 162 F.3d 410, 422
(6th Cir. 1998).
44
Id. at 422-423.
45
Id. at 423.
46
The trial court’s summary judgment order states that “[t]he
plaintiffs do maintain standing in regard to KRS 141.020, which
relates to an individual income tax paid by them.” Appellants’
Brief, Appendix 3, p. 4.
-15-
resolving such a matter, including whether the Davises can
properly represent any corporations, trusts or estates. 47
IV.
CONCLUSION.
For the foregoing reasons, the Jefferson Circuit
Court’s order granting summary judgment to the Department of
Revenue is vacated; and this case is remanded for further
proceedings consistent with this opinion.
ALL CONCUR.
BRIEFS AND ORAL ARGUMENT FOR
APPELLANTS:
BRIEF AND ORAL ARGUMENT FOR
APPELLEES:
Irvin D. Foley
David W. Gray
Anthony Raluy
Louisville, Kentucky
Douglas M. Dowell
Frankfort, Kentucky
John R. Wylie
Chicago, Illinois
47
The Davises ask us to order the trial court to certify this as a
class action. We decline that invitation, however, as such an issue
is one which must be initially determined by the trial court.
-16-
Some case metadata and case summaries were written with the help of AI, which can produce inaccuracies. You should read the full case before relying on it for legal research purposes.
This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.