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October 21, 2013

ZOELLER: Lawsuit asks if IRS can tax government

Can the IRS require Indiana’s state government to pay a tax penalty just like any other employer? The answer will set a precedent that goes to the fundamental relationship between states and the federal government. Much confusion exists over the lawsuit my office recently filed against the IRS, similar to the confusion over the Affordable Care Act (ACA) itself. Simply put, our lawsuit seeks a declaration by the court as to what the law means and how it affects state government.

We raise these questions respectfully, but since litigation is adversarial by nature some view this as an extension of political arguments in Washington, D.C. regarding the ACA. Our case is part of the constitutional process by which new laws are tested and our judicial branch interprets their meaning. Obtaining a conclusive answer from the judiciary is important so that as the state’s lawyer I can provide proper legal advice to my government clients.

State government does not pay federal income taxes and the federal government does not pay state income taxes. This is called intergovernmental tax immunity, part of dual sovereignty and a bedrock of our constitutional system. As an employer, state government withholds taxes from the compensation we pay our employees who owe state and federal taxes. But state government itself does not fill out an IRS income tax form. So when the U.S. Supreme Court ruled that the ACA was constitutional under Congress’ authority to impose taxes, it naturally raised the question whether states also would be subjected to the ACA employer mandate’s tax penalties. The IRS now seeks to impose tax authority over state government. If that occurs, it would significantly alter the relationship between the federal government and states in a negative way.

My office does not represent individuals or private sector employers but rather the sovereign authority of Indiana. When we realized state government could face tens of millions of dollars in IRS tax penalties if even one part-time state employee was misclassified in their benefits-eligibility category, I decided to proactively bring this question to the courts, rather than wait for the state to be hit with an enormous tax bill – a penalty that would only serve to transfer state and local tax dollars to the federal IRS. We seek relief from the employer mandate for state government and schools; but it will be up to the court to structure a remedy. Our lawsuit does not challenge the ability of citizens to shop for insurance coverage using the new federal exchange or to insure young people on their parents’ plans to age 26; it asks whether the IRS is correctly interpreting the ACA statute Congress passed.

As Attorney General, my obligation is to defend our state’s authority and the decisions of our state’s policymakers. Usually this means defending the state when it is sued by plaintiffs. But from time to time the state must initiate its own lawsuits challenging federal actions that infringe upon our state’s authority. This is one of those rare occasions.

Greg Zoeller is attorney general of Indiana.

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