SC Administrative Law Court Decisions

STATEMENT OF THE CASE AND PROCEDURAL HISTORY WITH THE ADMINISTRATIVE LAW JUDGE DIVISION

Anonymous Taxpayers or State Retirees ("Petitioners") filed a tax refund request with the South Carolina Department of Revenue ("Department") on May 20, 1999, seeking full tax exemption of their retirement benefits. The Department failed to act upon the request and Petitioners filed a declaratory judgment action in circuit court. Petitioners contended in their circuit court action that they did not have to pursue the administrative remedy included in the Revenue Procedures Act. Therefore, the Department did not act on Petitioners' request until after the Supreme Court's decision in Evans v. State, 344 S.C. 60, 543 S.E.2d 547 (2001). After the Supreme Court in Evans determined that Petitioners must first exhaust their administrative remedy, this matter was filed by Petitioners with the Administrative Law Judge Division ("Division") as a contested case. Petitioners seek full consideration of their tax refund claims.

Subsequent to the assignment of the case to the undersigned, the Department filed a Motion to Dismiss. A hearing on the Motion was held on July 25, 2001. At the motion hearing, the parties agreed that the Department would issue forthwith a "determination letter" and thereafter the parties could file pleadings and commence discovery. The Department issued its Final Agency Determination on August 31, 2001. In its determination letter, the Department held that the repeal of Act 189 of the entire exemption for state retirement benefits for state filers did not result in an impairment of the obligation of contract in violation of the federal and state constitutions, nor did it constitute a taking without just compensation or a deprivation of property without due process. In its determination the Department also determined that the statute of limitations barred Petitioner's claim and that Petitioners were not entitled to file a class action refund claim.

A scheduling conference was held with the parties on September 18, 2001. An Order was issued on October 3, 2001 memorializing the understandings made and approved by the court at the conference. At the conference, the parties stated their intent to file Motions for Summary Judgment. An amended Scheduling Order was issued on October 10, 2001 which established a schedule for the filing of legal briefs by both parties and which set a hearing on the Motions for January 23, 2001. The court agreed to withhold and reserve for a future date consideration of the issue of the class action request by Petitioners.

Petitioners now seek to resolve through this contested case the merits of their claim that the elimination of the tax exemption for State Retirees violated the Contracts, Takings, and Due Process Clauses of the United States and South Carolina Constitutions. A hearing was held on Wednesday, January 23, 2002, at which the parties presented oral arguments on their respective Motions for Summary Judgment.

PROCEDURAL BACKGROUND IN THE LEGISLATIVE AND JUDICIAL BRANCHES

This case is an outgrowth of the United States Supreme Court's decision in Davis v. Michigan Department of Treasury, 489 U.S. 803 (1989). In Davis the court held that 4 U.S.C.A. § 111 ⁽¹⁾ and the modern doctrine of "intergovernmental tax immunity" ⁽²⁾ prohibit states from taxing federal government retirees at a rate greater than they tax state and local government retirees. As the Supreme Court noted in Bass v. State, 302 S.C. 250, 395 S.E.2d 171 (1990), vacated, 501 U.S. 1246 (1991) (Bass I), prior to Davis state retirement benefits were fully exempt from state income taxation in South Carolina while federal retirees and private sector retirees were allowed only a three thousand ($3,000.00) dollar deduction.

Davis held that the taxing scheme in Michigan favored retired state and local government employees over retired federal employees and was a discrimination against federal employees on the basis of the source of their compensation. Further, the Court noted that any state that had such discriminatory provision which taxed federal retirees, but not state retirees, on their government retirement benefits, could cure the legal infirmity "either by extending the tax exemption to the federal employees (or to all retired employees), or by eliminating the tax exemption for retired state and local government employees." Davis, 489 U.S. at 818 (emphasis added). ⁽³⁾ Paul S. Davis, the retired federal employee who brought the action, was allowed to seek a refund to the extent he paid taxes pursuant to the invalid Michigan scheme.

When Davis was decided, roughly half of the states taxed state, federal, and military pensioners differently. After Davis, these states employed various methods to remedy the violation of the intergovernmental tax immunity doctrine, ranging from exemptions for all state, federal, and

military retirees, to partial exemptions, or to full taxation of all retirees. Pierce v. State of New Mexico, 121 N.M. 212, 217-218, 910 P.2d 288 (1995).

Davis mandated a change in state law in South Carolina. Accordingly, the South Carolina General Assembly enacted Act No. 189, § 39, S.C. Acts 1436 ("Act No. 189") in 1989, which was codified at S.C. Code Ann. § 9-1-1680 (South Carolina Retirement System), § 9-8-190 (Retirement System for Judges and Solicitors), § 9-9-180 (Retirement System for Members of the General Assembly), and § 9-11-270 (Police Officers Retirement System). ⁽⁴⁾ This legislation amended four provisions in Title 9, Chapters 1, 8, 9, and 11, of the South Carolina Code ("Retirement Code") to delete the full exemption from state income tax on state retirement benefits that the State Retirees had previously enjoyed. The South Carolina Supreme Court noted in 1990 that the South Carolina General Assembly amended state law "so as to comply with Davis." Bass I, 395 S.E.2d at 172.

S.C. Code Ann. § 9-1-1680 (Rev. 1986) was amended to delete the statutory exemption for state retirees' benefits in excess of three thousand ($3,000.00) dollars. In the same act, however, the General Assembly increased the retirement (pension) benefits for State Retirees by seven (7%) per cent to offset the increased tax liability resulting from the decreased exemption. After the passage of Act 189, Petitioners were and continue to be allowed the same three thousand dollar ($3,000.00) exemption that was previously allowed for federal and non governmental retirement benefits. See Act No. 189, § 39, 1989 S.C. Acts 1436 (codified at S.C. Code Ann. §§ 9-1-1680, 9-8-190, 9-9-180, and 9-11-270).

In July 1998, Petitioners ⁽⁵⁾ commenced a declaratory judgment action in circuit court against the State of South Carolina, the Budget and Control Board, the Department of Revenue ("Department"), and various State Retirement Systems (all collectively hereinafter referred to as "the State" or "State"). In that action, Petitioners alleged, inter alia, causes of action for breach of contract, unconstitutional impairment of contract, taking without just compensation, and denial of due process of law, challenging the constitutionality of Act 189 in its elimination of the full tax exemption for state retirement benefits. ⁽⁶⁾ Further, Petitioners sought an injunction against future imposition of state income taxes on their retirement benefits and damages in the form of an income tax refund for state income taxes paid on their retirement benefits.

In January 2000, the State filed a motion to dismiss Petitioners' action pursuant to Rule 12(b)(6), SCRCP. The motion to dismiss was based on Petitioners' failure to pursue their administrative remedies under the Revenue Procedures Act (S. C. Code Ann. §§ 12-60-10 to 3390 (2000)). It was denied by the circuit court and dismissed on other grounds. That order was appealed.

In March 2001, the South Carolina Supreme Court issued its ruling in Evans v. State, 344 S.C. 60, 543 S.E.2d 547 (2001). The Supreme Court held that "the circuit court erred by denying the State's motion to dismiss as required by § 12-60-3390 for the State Retirees' failure to exhaust their administrative remedies." Evans, 543 S.E.2d at 551. The court cited prior case law which held that "where there was no excuse for failing to exhaust administrative remedies, trial judge abused his discretion in finding plaintiff did not have to exhaust his administrative remedies." Hyde v. South Carolina Dep't of Mental Health, 314 S.C. 207, 442 S.E.2d 582 (1994).

In their argument before the circuit court, Petitioners argued that it would be futile to pursue the administrative remedies provided by the Revenue Procedures Act because neither the Department nor an Administrative Law Judge ("ALJ") could rule on the merits of their claims. More importantly, they asserted that their constitutional causes of action were "challenges to the facial validity of Act 189, claims which the separation of powers doctrine preclude executive branch officers from determining, not a request for a tax refund." Evans, 543 S.E.2d at 550. The Supreme Court rejected this argument, noting it had recently addressed a similar issue in Ward v. State, 343 S.C. 14, 538 S.E.2d 245 (2000).

In recognizing that the separation of powers doctrine prohibits an agency and an administrative law judge ("ALJ") from ruling on the constitutionality of a statute, the court noted that "an agency or ALJ can still rule on whether a party's constitutional rights have been violated. Merely asserting an alleged constitutional violation will not allow a party to avoid an administrative ruling." Ward, 343 S.C. at 18. The Court held that Petitioners were not challenging the facial validity of Act 189 as a whole, but rather were challenging Act 189 as it applied to a limited class of state employees. Accordingly, the Court reasoned that the Department and "the ALJ division have authority to rule on State Retirees' constitutional claims" because state retirees were "in actuality ... only challenging Act 189 as it applies to a limited class of state employees." Evans, 543 S.E.2d at 550 (emphasis added). Thus, "pursuant to Ward, the DOR [Department of Revenue] and ALJ Division have authority to rule on State Retirees" constitutional claims." Id. ⁽⁷⁾

Additionally, the Supreme Court reversed the circuit court's dismissal of Petitioners' (State Retirees') constitutional claims under Rule 12(b)(6), concluding that the circuit court had erred in deciding, on a Rule 12(b)(6) motion, the "novel issue" of "whether by passing Act 189 the General Assembly impaired [State Retirees'] contracts with the Retirement Systems or took their property without just compensation." Evans, 344 S.C. at 68-69, 543 S.E.2d at 551. The Court cited prior case law wherein it held that as a general rule, important questions of novel impression are best decided in light of the testimony to be adduced at trial. Tyler v. Macks Stores of South Carolina, Inc., 275 S.C. 456, 272 S.E.2d 633 (1980).

ISSUES

• Do Petitioners have a contractual right to the full tax exemption?
• If there is a contract, was it breached by the 1989 amendment to § 9-1-1680 which eliminated the full exemption and substituted a partial one?
• If there was a contract, was it impaired substantially in violation of U.S. Const. Art. I, § 10 and S.C. Const. Art. I, § 4?
• Was the impairment reasonable or necessary to accomplish a legitimate public purpose?
• Did the repeal of the full tax exemption constitute a taking of property without just compensation and was it a deprivation of property without due process of law, in violation

of the Fifth and Fourteenth Amendments to the United States Constitution and S.C. Const. Art. I, § 13?

• Are the Petitioners entitled to the full tax exemption of their retirement benefits?
• Did the Department illegally or wrongfully collect excess taxes from the Petitioners?

FINDINGS OF FACT

Stipulations by the parties

• Petitioner Victor S. Evans retired from state government service (South Carolina) in 1997

after having completed thirty (30) or more years of active service.

• At all times during his active service, Petitioner Evans was a member in good standing of the

South Carolina Retirement System ("System").

• At the time Petitioner Evans had completed five (5) years of service with state government,

S. C. Code Ann. § 9-1-1680 provided as follows:

§ 9-1-1680. Exemption from taxation and legal process; assignment

The right of a person to an annuity or a retirement allowance or to the return of contributions, an annuity or retirement allowance itself, any optional benefit or any other right accrued or accruing to any person under the provisions of this chapter, and the moneys of the System created hereunder, are hereby exempted from any State or municipal tax and exempted from levy and sale, garnishment, attachment, or any other process whatsoever and shall be unassignable except as herein specifically otherwise provided.

• In 1989, the exemption from South Carolina income taxation available to members of the

System was eliminated by 1989 Act No. 189, § 39, effective July 1, 1989.

• Since his retirement, Petitioner Evans has been subjected to income tax by the State of

South Carolina on the retirement allowance paid to him by the System.

DISCUSSION

Contract Clause

Petitioner claims that the State's passage of Act No. 189, which eliminated the full tax exemption for state retirement benefits (and provided thereafter only an annual exemption of three thousand ($3,000.00) dollars from state income taxation) and which simultaneously raised the retirement benefits of all state retirees (including Petitioner) by 7%, unconstitutionally impaired the obligation of contract. Petitioners assert that the State contractually promised them, as state retirees, through former § 9-1-1680 (and analogous provisions), that their retirement benefits would be exempt from state income taxation. ⁽⁸⁾

The United States Constitution and the South Carolina Constitution prohibit states from passing legislation that impairs the obligations of contracts. U.S. Const. art. I, § 10; S.C. Const. art. I, § 4. "The mandate of the state and federal constitutions relating to impairment of contracts is basically the same." Ken Moorhead Oil Co., Inc. v. Federated Mutual Ins. Co., 323 S.C. 532, 539, 476 S.E.2d 481, 485 (1996) (quoting G-H Ins. Agency v. Continental Ins. Co., 278 S.C. 241, 246, 294 S.E.2d 336, 339 (1982). Accordingly, the South Carolina Supreme Court follows federal precedent construing the federal Contract Clause when interpreting the Contract Clause of the South Carolina Constitution. Alston v. City of Camden, 471 S.E.2d 174, 322 S.C. 38 (1996).

The United States Supreme Court has established a three-step test for determining whether a law violates the Contract Clause. Ken Moorhead Oil Co., 323 S.C. at 539, 476 S.E.2d at 485 (citing federal authorities).

(1) First, the challenged law must actually impair the contract at issue. Id. (citing United States Trust Co. v. New Jersey, 431 U.S. 1, 17 (1977)).

(2) Second, the impairment must be substantial. Id. (citing Allied Structural Steel Co. v. Spannaus, 438 U.S. 234, 244 (1978)).

(3) Third, "unless a law that substantially impairs a contractual obligation is 'reasonable and necessary to carry out a legitimate governmental purpose,' the law violates the Contract Clause." Id. (citing Citizens for Lee County v. Lee County, 308 S.C. 23, 30, 416 S.E.2d 641, 646 (1992); accord Baltimore Teachers Union v. Mayor of Baltimore, 6 F.3d 1012, 1018 (4^th Cir. 1993), cert. denied, 510 U.S. 1141 (1994)).

In order to demonstrate a contract clause violation, Petitioners must establish all three elements.

Does the Retirement Code constitute a Contract with state retirees-question of state law. Before this tribunal can review the question of a contract impairment, it must first determine if the Retirement Code in South Carolina, as passed by our General Assembly, creates a contract between the State of South Carolina and private parties (the members of the Retirement Systems). The existence of a contract generally is a question of state law for purposes of determining whether there is a contract subject to impairment pursuant to the contract clause of the Federal and State Constitutions. Alston, 471 S.E.2d at 177, citing Indiana ex rel. Anderson v. Brand, 303 U. S. 95, 100 (1938). The issue herein is a novel question of law in South Carolina and the terms of the statutes at issue must be examined to determine if a contract exists. Further, it is important to look at other jurisdictions and see how they have interpreted their statutes. Also, this tribunal must examine any prior rulings that have addressed the construction, nature of, or obligations of the Retirement Code.

(1) Contract rights between State and third parties--Alston. The Supreme Court of New Mexico has described well the evolution of statutory pension plans. Pierce, et al. v. State of New Mexico, et al, 121 N.M. 212, 910 P.2d 288 (1995). Historically, "the unquestioned rule [was] that a pension granted by the public authorities [was] not a contractual obligation, but a gratuitous allowance, in the continuance of which the pensioner has no vested right." Annotation, Vested Right of Pensioner to Pension, 54 A.L.R. 943 (1928). A contrary view was introduced in 1904 when an amendment to a teacher's retirement plan was held to create a contractual relationship. Ball v. Board of Trustees, 71 N.J.L. 64, 58 A. 111 (1904). Participation in the plan discussed in Ball was voluntary and the terms of the relationship were specified in the statute.

States continue to be influenced by these two views. The test frequently used to determine the legal nature of the employee's interest frequently turns on whether the plan features mandatory or voluntary participation. However, the modern trend generally agrees that the voluntary/mandatory test is becoming archaic and inappropriate since the state pension plans are becoming voluntary. Connecticut recognizes a "vested right" to receive pension benefits created by statute, which accrues once a retiree satisfies the requirements for eligibility. This right is protected by the due process provisions of the state and federal constitutions. New Jersey has reasoned that the mandatory

retirement benefits are neither contractual nor vested rights but possibly "property rights" in the retirement fund. ⁽⁹⁾

Until the South Carolina Supreme Court issued its ruling in Alston v. City of Camden, 322 S.C. 38, 471 S.E.2d 174 (1996), there was no South Carolina case which stated the circumstances under which a statute or ordinance would be regarded as constituting a contract with a private party. Since Alston, the law in South Carolina is clear that "public employees generally have no contractual rights in their employment merely by virtue of a statute describing the terms of that employment." Alston, 471 S.E.2d at 177, citing Plowden v. Beattie, 185 S.C. 229, 193 S.E. 651 (1937) (emphasis added). In Plowden, the court held that, "subject to the Constitution, the General Assembly may fix the term, provide for removal, abolish the office, reduce the term, and in every respect control the existence, powers, emoluments and tenure of public officers." 185 S.C. at 237, 193 S.E. at 655.

In Plowden, the court had held that "public officers are created for the benefit of the commonwealth" and that "incumbents have no contract or property rights in them" unless otherwise provided by the constitution. Based upon this principle expressed in Plowden, the court in Alston held that there is a presumption that statutes which regulate salaries and benefits of public employees do not create contractual rights for those employees.

(2) Presumption in South Carolina that legislative acts are to establish policy, not make contracts. The rationale for the presumption in South Carolina that statutes generally do not create contractual rights, binding future legislatures, was best described in Alston:

[A]bsent some clear indication that the legislature intends to bind itself contractually, the presumption is that "a law is not intended to create private contractual rights or vested rights but merely declares a policy to be pursued until the legislature shall ordain otherwise." This well-established presumption is grounded in the elementary proposition that the principal function of a legislature is not to make contracts, but to make laws that establish the policy of the state. Policies, unlike contracts, are inherently subject to revision and repeal, and to construe laws as contracts when the obligation is not clearly and unequivocally expressed would be to limit drastically the essential powers of a legislative body.

Alston, 471 S.E.2d at 178 (emphasis added), (quoting National R.R. Passenger Corp. v. Atchison, Topeka, & Santa Fe Ry. Co., 470 U.S. 451, 465-66 (1985) (quoting Dodge v. Board of Educ., 302 U.S. 74, 79 (1937)). In Alston, employees of the City of Camden were given certain defined fringe benefits (annual leave, sick leave and health insurance benefits) pursuant to an ordinance. When the City of Camden repealed the ordinance, which reduced the benefits to its employees, various employees brought an action claiming the personnel ordinance(s), together with the existence of an employee handbook, evidenced an intent by the City of Camden to enter into contractual relations with its employees. The Supreme Court found that the original employee handbook was undated and that it was unclear whether the handbook was issued contemporaneously with the passage of the personnel ordinances or sometime later. It held that the employees had not met their burden of overcoming the presumption that the ordinances did not create private contract rights.

(3) Is it labeled a contract? Petitioners argue that the four chapters of the Retirement Code provide in part that "[a]ll agreements or contracts with members of the System pursuant to any of the provisions of this chapter shall be deemed solely obligations of the Retirement System . . . ." S.C. Code Ann. § 9-1-1690 (1986) (emphasis added); see also § 9-8-200, § 9-9-190, and § 9-11-280 (1986) (containing virtually identical language). Thus, they argue that the Retirement Code itself recognizes the creation of contracts between the Retirement Systems and their members. See Indiana ex rel. Anderson v. Brand, 303 U.S. 95, 105 (1938) (holding that an act "couched in terms of contract" and using contractual language gave rise to a Contract Clause claim). ⁽¹⁰⁾

(4) Form of the contract--Unilateral. Petitioners posit that the contract envisioned by the Retirement Code provisions is in the form of a unilateral contract. See McMahan v. McMahon, 122 S.C. 336, 340, 115 S.E. 293, 294 (1922) (defining "unilateral contract" as one in which there is a promise on one side only, consideration on the other side being executed); Restatement (Second) of Contracts § 52 ("In a unilateral contract the act requested and performed as consideration for the contract ordinarily indicates acceptance as well as furnishes the consideration . . . ."). ⁽¹¹⁾ Petitioners argue that the terms of the offer of this unilateral contract are contained in the statute(s) and, the acceptance of those terms is manifested by Petitioner's performance of their obligations, including membership in the System, contributing to the applicable Retirement System, and achieving the required years of service for vesting. ⁽¹²⁾ Cf. Alston, 322 S.C. at 46, 471 S.E.2d at 178 (quoting National R.R. Passenger Corp. v. Atchison, Topeka, & Santa Fe Ry. Co., 470 U.S. 451, 465-66 (1985)).

Our Supreme Court has held, and the State has conceded, that retirement benefits are deferred compensation. Ball v. Ball, 314 S.C. 445, 447, 445 S.E.2d 449, 450 (1994). Petitioners argue that the only basis for the payment of the deferred compensation is by contract. Further, they posit that the fact that a portion of the compensation is deferred does not lessen the contractual obligation of the State to pay it. Thus, Petitioner's argument that the requirements of a unilateral contract have been met in this factual situation, i.e.,where state employees furnish service to the state, become members of the state retirement system, and upon retirement receive the deferred compensation which is the consideration for the services they have already rendered, has great merit.

(5) Intent to be bound by the contract. Alston held that personnel ordinances did not demonstrate an intent by the city to bind itself contractually to the employees. It held that the purpose of the ordinances was to express the city's policy to establish a standardized personnel system and for its implementation as efficiently as possible. Further, the court held that even if the employee handbook which contained the fringe benefits constituted a contract, the employees had no reasonable expectation that the terms of the contract would remain unchanged. ⁽¹³⁾

In general, a statute is treated as a contract only when the language of the contract and circumstances evince a legislative intent to create private rights of a contractual nature enforceable against the State. Thus, if the terms of the statute clearly indicate a legislative intent to create a contract, the inquiry ends.

(6) Necessary legislative intent. The South Carolina Supreme Court, in Ken Moorhead Oil Co., Inc. v. Federated Mut. Ins. Co., 323 S.C. 532, 476 S.E.2d 481 (1996), held that statutes can create contractual obligations between the state and a private party that requires the state to spend its funds in some particular way, and if the state retroactively repeals such a statute, then a party to that statutory contract may have a cause of action under the contract clause. This case addressed an issue arising from the passage in 1988 by the South Carolina General Assembly of the South Carolina State Underground Petroleum Environmental Response Bank Act, S.C. Code Ann. §§ 44-2-10 et seq. (the "Superb Act"). The act created the "superb account" which was a fund to rehabilitate sites which had underground petroleum storage tanks. Upon meeting certain criteria, the owner/operator of an underground petroleum storage tank could report site contamination and receive funds from the account "without recourse to reimbursement or recovery." Moorhead, 476 S.E.2d at 484. In this case, the court not only recognized the existence of a contract between private parties and the state which was authorized by statute, it provided an analysis of the requirements required to establish an impairment of a contract in order to bring a cause of action under the Contracts Clause.

Respondent argues that several cases in South Carolina seem to imply that retirement benefits are statutory, not contractual, in nature. In McKinney v. South Carolina Police Officers Retirement System, 311 S.C. 372, 429 S.E.2d 797 (1993), the plaintiff established 25 years of service in the state retirement system, all as a bus driver and as a uniformed officer for the City of Camden and Kershaw County. His claim made at the hearing for additional benefits for service as an undercover agent was denied. The court held that there was no binding contract for the services he provided as an undercover agent. McKinney argued before the administrative hearing officer that certain correspondence had been directed to him by the Kershaw County Sheriff's Department which constituted an offer of a contract which he accepted; further, he argued such constituted a contract for which he should be entitled to additional retirement benefits. The court stated that "McKinney misconstrues the nature of his right to retirement benefits: the source of his right is the statutes, not a contract." Citing Anderson v. South Carolina Retirement System, 278 S.C. 161, 293 S.E.2d 312 (1982), the court held that "Neither McKinney nor respondent have the authority to convert this statutory right into a contractual one."

Respondent interprets this statement in McKinney as a holding by the court that retirement benefits are statutorily created and are not contractual. However, this interpretation is incorrect. It is true the retirement system is created by statute and not by individual contracts with state retirees. However, the statute provides for the state to enter into contracts with state employees which become obligations of the state. The court is merely saying that McKinney's right to retirement benefits is pursuant to the statutes which created the retirement program, not some separate written contract. ⁽¹⁴⁾ The Retirement Code provided the basis for the unilateral contract between state employees and the state.

Respondents also argue authority from seven other states which they contend supports the proposition that "the majority of state courts that have considered the question have rejected impairment of contract claims based upon the repeal of tax exemptions of retirement benefits." Those cases are distinguishable from this case. They are:

(1) The retirement board in New Mexico has, by statute, the specific right to modify the amount of benefits payable. Pierce v. State of New Mexico, 121 N.M. 212 (1995);

(2) In Colorado, the tax exemption is located in the tax statute, is not located in the retirement code and does not refer to state retirement benefits. Spradling v. Colorado Dept. of Revenue, 870 P.2d 521 (Colo. Ct. App. 1993);

(3) In Georgia, there is a constitutional provision which prohibits the state legislature from granting an irrevocable tax exemption. Parrish v. Employees' Retirement Sys., 398 S.E.2d 353 (Ga. 1990);

(4) In Maine and Montana there is a constitutional provision which prohibits the legislature from contracting for a tax exemption. The legislatures are never authorized in any manner, to suspend or surrender the power of taxation. Blair v. State, 485 A.2d 957 (Maine 1984); Sheehy v. Public Employees Retirement Div., 864 P.2d 762 (Mont. 1993);

(5) In Ohio, there was a provision in the retirement statute which enumerated benefits that were protected from subsequent reduction by the legislature and, the tax exemption was not included therein. Thus, the court held the retirement benefits were not protected from future reduction. Herrick v. Lindley, 391 N.E.2d 729 (Ohio 1979);

(6) In Rhode Island, the court did not address the issue in this case but disposed of the case on other grounds. Linnane v. Clark, 557 A.2d 477 (R.I. 1989).

(7) Clear indication of legislative intent. Petitioners argue that a clear indication of legislative intent can be something less than an express statement such as: "This statute creates a contract." ⁽¹⁵⁾ They note that Alston does not require such magic words which is apparent from the court's analysis of other factors. For example, in addition to reviewing the language of the statute, Alston indicates that the circumstances of the passage of the act under review is a relevant factor. See Alston, 322 S.C. at 46, 471 S.E.2d at 178 (citing Pineman v. Fallon, 662 F. Supp. 1311, 1316 (D. Conn. 1987), aff'd, 842 F.2d 598 (2d Cir.), cert. denied, 488 U.S. 824 (1988)). The General Assembly created the Retirement System in 1945. Despite the fact that a tax code providing for income tax had been on the books since 1926, the General Assembly chose to enact the exemption from state taxation as a retirement benefit along with the other retirement benefits created at the same time rather than enacting a separate tax exemption for state retirement benefits in the tax code. The General Assembly again enacted the exemption benefit along with other retirement benefits in 1962 when it created the Retirement System for Members of the General Assembly and the Police Officers Retirement System and in 1979 when it created the Retirement System for Judges and Solicitors. See §§ 9-8-20, -190; §§ 9-9-20, -180; and §§ 9-11-20, -270. Thus, the circumstances of the passage of the Retirement Code evince a legislative intent to include the exemption from state taxation as a retirement benefit to which the State Retirees would have contractual or vested rights. See Hughes v. Oregon, 838 P.2d 1018, 1032 (Or. 1992); see also Bailey v. North Carolina, 500 S.E.2d 54, 63 (1999).

Although the court held in Alston that the ordinance at issue merely expressed a policy intention to provide a uniform personnel system, by contrast the Retirement Code has language which states that it was created "for the purpose of providing retirement allowances and other benefits for teachers and employees of the State and political subdivisions or agencies or departments thereof." S.C. Code Ann. § 9-1-20 (1986) (emphasis added); see also S.C. Code Ann. § 9-8-20 (1986); § 9-9-20 (1986); § 9-11-20 (1986) (all containing basically the same language as § 9-1-20). This language is supportive of the State Retirees' assertion that the General Assembly intended for the State Retirees to have either contractual or vested property rights in all of the benefits contained in the Retirement Code, which included the tax exemption.

(8) Other factors indicating legislative intent. Petitioners argue other factors which indicate a legislative intent to create a contract. They cite Bailey v. North Carolina, 500 S.E.2d 54 (N.C. 1999), ⁽¹⁶⁾ wherein the North Carolina Supreme Court examined the precise issue before this court. In determining that the North Carolina retirement statutes constituted a contract, the court considered such factors as: (1) the creation of various statutory tax exemptions for retirees by the legislature; (2) the location of those provisions alongside the other statutorily created benefit terms instead of within the general income tax code; (3) mandatory participation; (4) withholding from employees' periodic wages of the employee contribution amount, and; (5) the establishment of a set time period for vesting. These same factors are present in this case.

(9) Reservation of right by the State to amend the Retirement Code. Petitioners cite S.C. Code Ann. § 9-1-50 (1986) as further support for their argument. In that section, the State "reserves the right" to revise the System in the event of certain changes to the federal Social Security Act. Petitioners argue that if the State felt it needed to include a provision reserving its right to amend the statute for that purpose, then such demonstrates that the State did not reserve the right to amend the terms of the statute in other ways, including the deletion of the tax exemption.

Respondent argues that the state does have the authority to amend the statute and is not bound contractually to provide the exemption since the retirement allowance for state retirees is in the present tense. Petitioners agree and state that the General Assembly has amended the Retirement Code numerous times since its initial passage. However, Petitioners assert that the tax exemption provisions of the Retirement Code can be amended only if the repeal of such provisions does not apply to Petitioners, whose rights in the retirement system have already vested. Further, in contrast to the facts in both Wage Appeal v. Board of Personnel Appeals, 676 P.2d 194 (Mont. 1984) and in Alston, the dispute here is over a contractual obligation to pay benefits already earned (i.e., deferred) and not over benefits of current employment.

In North Carolina, the courts have made it abundantly clear that a government employee has contractual rights to his deferred compensation, already earned, which is merely transubstantiated over time into a retirement allowance. "The agreement to defer the compensation is the contract." Bailey, 500 S.E.2d at 60. The court in Bailey found that fundamental fairness dictates this result. Further, the North Carolina court stated that "the retirement benefits of all employees whose retirement rights became vested prior to 12 August 1989 must be exempt from state tax without regard to whether those benefits are attributable to service prior to or after that date." Bailey, 500 S.E.2d at 61. It noted that earlier North Carolina decisions involving the governmental provision of pensions were similarly rooted in the protection of expectational interests upon which individuals have relied through their actions, and that such individual actions gave them a vested right. Further, in that class action, the court held that "a reasonable person would have concluded from the totality of the circumstances and communications made to plaintiff class members that the tax exemption was a term of the retirement benefits offered in exchange for public service to state and local governments." Bailey, 500 S.E.2d at 146.

The court in Bailey compared the exemption granted to state retirees to the exemption granted to taxpayers who purchased tax exempt bonds. It noted that the state issues municipal bonds to raise money. In exchange for its payment of a lower rate of interest on this indebtedness, the state agrees to provide an exemption to forgo taxation of the income or gain on the bonds. A similar public policy is involved with public employees and state retirees. In order to induce them to work for the state and continue in state employment, the state agrees to exempt from state income taxation their state retirement benefits. Both exemptions serve a public purpose. Not only does the state need to borrow money from time to time, it must also compete with private employment to attract and keep quality public servants while generally paying lower wages.

Summary. After consideration of all of the above, including the factors contained in Bailey, which are present in this case, this court must conclude that the South Carolina General Assembly intended all the benefits contained in the Retirement Code to be both contractual rights and vested rights. The Retirement Code clearly provides the terms of a classic unilateral contract (offer, communication of the offer to the employee and performance of job duties in reliance on the offer), one of the benefits of which is an exemption from taxation on retirement allowances. The provisions of the Retirement Code promise benefits upon retirement; they are more than a chance for benefits. The cases cited by Respondent from other jurisdictions, excluding North Carolina, which have addressed this issue since Evans, are all distinguishable from this case. The Retirement Code must be read as a whole, giving effect to all of its parts and in light of its intended purpose. When done so, the only conclusion that this court can make is that a contract exists between the state and these state retirees to provide the full tax exemption for state retirement benefits as codified prior to Evans. These benefits are vested in Petitioners and are not subject to change by statute.

The General Assembly created the Retirement System for the purpose of providing a package of retirement benefits. See § 9-1-20; § 9-8-20; § 9-9-20; § 9-11-20. It enacted the tax exemption benefit statutes at the same time it enacted the statutes outlining the State Retirees' other retirement benefits, as part and parcel of the Retirement Code. It included the tax exemption benefits in the Retirement Code among the other retirement benefits rather than in the general income tax code where other exemptions appear. § 9-1-1680, § 9-8-200, § 9-9-190, § 9-11-280. It required consideration from the State Retirees, including requiring them to participate in and contribute to the System. See §§ 9-1-420, -425, -1020; §§ 9-8-40(1), -130(1); §§ 9-9-40(1), -120(2); §§ 9-11-40(4), -210(1). The state directed the Retirement System to withhold State Retirees' periodic contributions from their wages. § 9-1-1020 (1986 & Supp. 1999); § 9-8-130(1) (1986); § 9-9-120(2) (1986); § 9-11-210(7) (1986). Finally, it established a set time period for vesting. It is for the benefit of the state to have good employees; to provide good employees the incentive to work for the state, there must be a good retirement plan.

In construing the Retirement Code, this body is constrained not only to read it as a whole, but also give effect to each of its sections and interpret it in light of its intended purpose. Gilfillin v. Gilfillin, 344 S.C. 407, 544 S.E.2d 829 (2001); Eargle v. Horry County, 344 S.C. 449, 545 S.E.2d 276 (2001). The Retirement Code is replete with multiple references to words of like import, including: "[a]ll agreements or contracts", "pledged and obligated", and "nonforefeitable" (§§ 9-1-20, 9-8-200, 9-9-190 and 9-11-280) "retirement allowances and other benefits" (§§ 9-1-20, 9-8-2, 9-9-20, and 9-1-20); "entitled" (§9-1-1650), and "vested" (§9-8-50(4)). See also S. C. Const. art. X, § 16 (referencing "liabilities" and "obligations to members" of the various retirement systems created under the Retirement Code). The language of the Retirement Code, read as a whole, gives rise to Petitioner's vested rights thereunder.

To change the taxability of the vested retirement benefits of Petitioners in South Carolina would be no different than if the state retrospectively repealed the tax free gain which investors bargain for when they purchase tax-free bonds from this state. The basis for prohibiting the state from doing so is fundamental fairness. Once the commitment is made by this state, and its derivative benefits are enjoyed by it, the state should not and can not remove this exemption no more than it can tax the interest on tax free bonds. Performance of the duties of the state employees has been completed and thereafter the terms of the unilateral contract are irrevocable. The pension is but a portion of compensation which is deferred. It is already in effect earned, and merely transubstantiated over time into a retirement allowance, which the employee has a contractual right to. This state is and must be guided by notions of fairness, consent and mutual respect between government and man, and a change in the contractual terms governing retirement benefits, after they have been accepted by the employees, does not comport with these guiding principles.

Impairment of Contract; Substantial Impairment; Reasonable and Necessary to Carry Out a Legitimate Governmental Purpose

Having determined that a contract exists between Petitioners and Respondent, the next step in the inquiry as to whether a statute violates the Contract Clause is whether an impairment exists

and, if so, whether the impairment was substantial. I find that the issue of the existence of an impairment and, if such an impairment does exist, whether it is substantial, must be developed through the taking of additional testimony and evidence by this tribunal and is not a proper issue for disposition in a motion for summary judgment. Accordingly, a hearing on the merits of the remaining issues in this case must be held.

Accordingly, it is hereby

ORDERED that the Petitioners' Motion for Summary Judgment is hereby granted as to the issue of whether the Retirement Code gives rise to a contract. The Petitioners' Motion is denied as to all remaining issues.

IT IS FURTHER ORDERED that the Respondent's Motion for Summary Judgment is hereby denied.

IT IS FURTHER ORDERED that a conference will be held at the offices of the Division on July 10, 2002 at 2:00 p.m. to discuss time frames for the resolution of the remaining issues in the case, including the conduct of any additional discovery, and for setting a date for the hearing on the merits of the remaining issues.

AND IT IS SO ORDERED.

__________________________________________

Marvin F. Kittrell

Chief Judge

Columbia, South Carolina

June 14, 2002

1. This statutory provision was enacted as part of the Public Salary Tax Act of 1939. The primary purpose of this provision was to impose federal income tax on the salaries of all state and local government employees. Prior to its adoption, the salaries of most government employees, both state and federal, were generally thought to be exempt from taxation by another sovereign under the doctrine of intergovernmental tax immunity. See McCulloch v. Maryland, 4 Wheat. 316, 4 L.Ed. 579 (1819) for the genesis of this doctrine. In McCulloch, the Supreme Court held that the State of Maryland could no t impose a discriminatory tax on the Bank of the United States--that to do so would interfere with the powers delegated to the federal government. There was much judicial revision of the immunity doctrine after McCulloch, Finally, Congress passed the Public Salary Act in 1939 which codified the broad taxing authority of the federal government as decided in Helvering v. Gerhardt, 304 U.S. 405, 58 S.Ct. 969, 82 L.Ed. 142 (1938). That decision upheld the imposition of federal income taxes on state civil servants.

2. The doctrine of intergovernmental tax immunity is based on the need to protect each sovereign's governmental operations from undue interference by another sovereign. However, private entities and individuals who are subjected to discriminatory taxation on account of their dealings with a sovereign will receive the same protection afforded by this doctrine. Davis, 109 S.Ct. at 1500.

3. With respect to the claim in the Davis case, the court noted that it was not in the best position to ascertain the appropriate remedy. However, it stated that it had previously "recognized, in cases involving invalid classifications in the distribution of government benefits, that the appropriate remedy " was "a mandate of equal treatment, a result that can be accomplished by withdrawal of benefits from the favored class as well as by extension of benefits to the excluded class." Davis, 109 S.Ct. at 1508.

4. By 1995, 23 states had addressed discriminatory tax exemption provisions.

5. The term Anonymous Taxpayers is sometimes referred to herein as "State Retirees". It consists of some current state employees who have not yet retired as well as some state employees who have already retired, which includes Victor S. Evans. They are further defined in Evans v. State, 543 S. E. 2d, at 550 as "those persons employed by the State, its political subdivisions, and agencies before June 8, 1989." Thus, they are a limited class.

6. Petitioners alleged violations of U.S. Constitution Article I, § 10 (impairment of contract), and the Fifth and Fourteenth Amendments to the U.S. Constitution (taking of property without just compensation and in violation of due process), as well as violations of S.C. Constitution Article I, § 4 (impairment of contract), Article I, § 13 (taking of property without just compensation), Article X, § 5 (tax levied without distinctly stating object), and Article V, § 16 (diminishing compensation for judges) (1976 and Supp. 2000).

7. The Revenue Procedures Act itself recognizes that constitutional claims may be presented to the Department and the Administrative Law Judge Division. S.C. Code Ann. § 12-60-3380 (Rev. 2000).

8. See also former S.C. Code Ann. §§ 9-8-190, 9-9-180 and 9-11-270 (1986) which were amended by the 1989 Act. For ease of reference, the discussion herein includes those corresponding provisions of the Retirement Act.

9. The courts in Connecticut (Pineman v. Oechslin, 195 Conn. 405 (1985)), Maine (Spiller v. State, 627 A.2d 513 (1993)), Minnesota (Christensen v. Minneapolis Mun. Employees Retirement Bd., 331 N.W.2d 740 (1983), New Jersey (Spina v. Consolidated Police & Firemen's Pension Fund Comm'n), 41 N.J. 391 (1964), Rhode Island (In re Almeida, 611 A.2d 1375 (1992), and New Mexico (Pierce v. State of New Mexico, 121 N.M. 212 (1995)) have expressly found that statutory retirement plans do not create contractual rights. They recognize that pensioners acquire an important property interest or right, but decline to find in the language of the statute a legislative intent to create a contract.

10. See Parrish v. Employees' Retirement Sys., 260 Ga. 613, 398 S.E.2d 353, 354 (1990), cert. denied, 500 U.S. 918 (1991). The dissent, citing Withers v. Register, 246 Ga. 158, 159, 269 S.E.2d 431 (1980), stated "it was the law of this state that a statute or ordinance establishing a retirement plan for government employees becomes a part of an employee's contract of employment if the employee contributes at any time any amount toward the benefits he is to receive, and if the employee performs services while the law is in effect."

11. "A unilateral contract has the following three elements: 1) a specific offer, 2) communication of the offer to the employee, and 3) performance of job duties in reliance on the offer." Towles v. United Healthcare Corp., 338 S.C. 29, ___, 524 S.E.2d 839, 844 (Ct. App. 1999) citing Prescott v. Farmers Tel. Coop., Inc., 335 S.C. 330, 336, 516 S.E.2d 923, 926. Respondent does not dispute that each of these elements exist in the instant case. Nor can Respondent dispute that the offer communicated to Petitioners included an exemption from South Carolina income tax on their state retirement benefits. See §§ 9-1-1680, 9-8-200, 9-9-190 and 9-11-280 (1976).

12. See § 9-1-420 (requiring membership in System); §§ 9-1-425 and 9-1-1020 (requiring employee contributions); § 9-1-1650 (establishing requirement for vesting in State Retirement System); § 9-8-50-(4) (establishing vesting requirement for Judges & Solicitors); § 9-0-40 (establishing vesting requirement for members of the General Assembly); § 9-11-60 (establishing vesting requirement for Police Officers).

13. In an aside, the court opined that "perhaps more important to the state and its municipalities, however, any ruling other than the one we issue today would cripple the efficient operation of government." Alston, 471 S.E.2d at 180.

14. Then Justice Toal, writing a dissenting opinion, referred to the retirement benefits as the "Contract for Retirement benefits." McKinney, 429 S.E.2d at 798.

15. This court can take judicial notice that many writings which unquestionably constitute a contract, such as leases and mortgages, do not expressly say that they create a contract and often do not even refer to themselves as such. In the present case, the contractual intent is even more definite, since the legislature referred to the State Retirees' rights as "agreements or contracts." Compare § 9-1-1690 (1986), § 9-8-200 (1986), § 9-9-190 (1986), and § 9-11-280 (1986) (referencing "agreements or contracts") with National Education Association v. Retirement Board, 172 F.3d 22, 28 (1st Cir. 1999) (finding no clear indication by the legislature of contractual intent in part because "[n]owhere does the statute call the pension plan a 'contract'").

16. After Davis, the North Carolina General Assembly passed during its 1989 session 1989 Session Laws chapter 792, section 3.9 ("the N.C. Act"). The N.C. Act authorized a $ 4,000.00 cap exemption to all governmental employees, including state, local and federal, on the amount of annual benefits that would be exempt from state taxation.