The Second Circuit Court of Appeals has affirmed the federal District Court’s dismissal of a complaint which challenged as unconstitutional a partial exemption from the New York sales tax on parking services. Joseph v. Hyman, No. 10-3943-cv (2d Cir. Oct. 12, 2011). The court held that improvements for the properties made after the valuation date could not be considered, an extortion of the time to resolve.

Motor vehicles parked in New York are subject to a 10.375% sales tax on parking services (comprised of a 4% State tax; a 6% New York City tax; and .375% Metropolitan Commuter Transportation District tax). New York City imposes an additional 8% sales tax if the parking services are rendered in Manhattan (“Manhattan surtax”).

In Joseph, a civil rights class action suit commenced in August 2009, the plaintiffs were commuters who park their cars in the City. They asserted that an exemption from the 8% Manhattan surtax available to certain Manhattan residents who purchase long-term parking is discriminatory and violates various provisions of the U.S. and New York State Constitutions. Estimates of the revenue impact of the exemption varied from $3 million to $22 million annually. The plaintiffs argued that, because the various State and City defendants “violated clearly established constitutional law” and “failed to act in an objectively reasonable manner,” they were not entitled to the qualified immunity that otherwise protects government officials. The plaintiffs also sought attorneys’ fees under 42 U.S.C. § 1988.

Two significant barriers to the plaintiffs’ action were the Tax Injunction Act, 28 U.S.C. § 1341 (“TIA”), which bars federal courts from taking any action to “enjoin, suspend or restrain the assessment” of a state tax “when a plain, speedy and efficient remedy” is available in state court, and the doctrine of comity, which comes from the Latin “comitas,” meaning friendly, and stands for the proposition that courts of one jurisdiction may accede or give effect to the decisions of another jurisdiction.

At the time this case was briefed at the District Court, two of the main cases dealing with the TIA and the comity doctrine were Fair Assessment in Real Estate Association, Inc. v. McNary, 454 U.S. 100 (1981) and Hibbs v. Winn, 542 U.S. 88 (2004). In Fair Assessment, the U.S. Supreme Court held that comity barred a suit brought in federal court to review a local property tax assessment, despite the fact that the action was brought under 42 U.S.C. § 1983 (“§ 1983”), which allows challenges against state laws to be brought in federal court. The Supreme Court held that comity precluded the commencement in federal court of § 1983 cases challenging state tax systems, as long as the state court remedies were “plain, adequate and complete.” However, in Hibbs, the Court held that neither the TIA nor principles of comity barred a federal suit challenging a state tax credit on the basis that the credit improperly channeled public funds to pay for parochial schools, because the relief sought by the Hibbs plaintiffs would not result in enjoining the collection of a tax or contesting the validity of a tax imposition, but rather challenged only a credit, and the success of the plaintiffs’ action would result in greater, rather than diminished, state tax collections.

Several federal circuit courts took a broad view of the route left open in Hibbs, and allowed certain actions to proceed in federal court. Then, in Levin v. Commerce Energy, Inc., 130 S. Ct. 2323 (2010), the Supreme Court narrowed the Hibbs exception, holding that the comity doctrine was “more embracive” than the TIA, and barred a challenge in federal court to Ohio’s taxation of gas marketers which was alleged to be discriminatory.

With that background, the District Court in Joseph dismissed the case, finding that no fundamental right was implicated in the parking tax exemption; that plaintiffs were not third party challengers of the tax (unlike the plaintiffs in Hibbs, plaintiffs were “objecting to their own tax burden, however indirectly”); and that the state court is “better suited than this Court to identify and implement the remedial option that best comports with the legislative evil.” The court also noted that plaintiffs had not alleged that the state remedies were insufficient.

In affirming the District Court’s decision, the Second Circuit added little to the analysis, but addressed plaintiffs’ assertion that the New York courts could not fashion adequate remedies, concluding that State courts could, if necessary, prevent enforcement of discriminatory tax provisions even if the result was a decrease in state tax revenue. The case was dismissed without prejudice, and resort to the New York State courts remains available to the plaintiffs to challenge the exemption.

Additional Insights. As recognized by the Second Circuit in Joseph, after Levin the bar to gain entry to the federal court system has been raised, and only those whose claims involve fundamental rights, or who can demonstrate that the state review system is inadequate, will pass the hurdle. Reliance on the notions that a tax credit or an exemption provision is implicated, rather than an assessment, or that a suit is commenced by a nontaxpayer, are unlikely to provide the entry ticket. While it may well be true, as the Iowa Supreme Court recently acknowledged in its decision in KFC Corp. v. Iowa Dep’t of Revenue, 792 N.W.2d 308 (Iowa 2010), cert. denied, 80 U.S.L.W. 3182 (Oct. 3, 2011), that state courts may be “inherently more sympathetic to robust taxing powers of states than is the United States Supreme Court,” the route to getting state tax disputes heard by the U.S. Supreme Court is a long one requiring bringing a case through the whole state court system and then hoping for a place on the U.S. Supreme Court’s extraordinarily limited docket.

It now remains to be seen whether the challenge to the exemption will be pursued in State court and, if so, how the New York courts will view the constitutional challenges.