CHICAGO -- The Iowa Department of Revenue and Finance will appeal a district court decision that could cost as much as $50 million in retroactive state income tax refunds to federal government pensioners, a state official said yesterday.

Earlier this month, Linn County District Court Judge Lynne Brady ordered the revenue department to refund state income tax payments made by Arlo Hagge, a retired federal employee in Cedar Rapids. The decision covered payments made by Mr. Hagge from 1985 to 1989.

Judge Brady favored Mr. Hagge's legal action, seen as a test for all federal pensioners in Iowa, reasoning that a 1989 Supreme Court ruling on a similar matter should be viewed retroactively.

Larry Cook, manager of taxpayer services for the state revenue department, said the petition of appeal will be filed with the state Supreme Court in August.

If the district court decision is upheld, Mr. Cook said, it could open the door to potential refunds to all federal employees in Iowa at a potential cost of $40 million to $50 million, Mr. Cook said.

"Everyone who was involved in the case knew that regardless of the district court's decision, the case would be appealed to the Iowa Supreme Court," Mr. Cook said.

State Treasurer Michael Fitzgerald said a ruling in favor of federal retirees would burden Iowa's already strained finances. He added that paying the refunds would require a 1% increase in revenue that would come from budget cuts or additional revenue resources.

"It would be a difficult pill to swallow," Mr. Fitzgerald said.

The case initially came to court when Mr. Hagge sought to retrieve state income tax refunds retroactively following the 1989 U.S. Supreme Court ruling. The court ruled that income tax laws that did not uniformly tax public employee benefits were unconstitutional. The nation's high court did not, however, clarify whether its decision applied only for future cases or retroactively as well.

Prior to 1989, Iowa taxed pensions of federal government retirees but not those of retirees from state or local governments.

In August 1991, the state revenue department denied Mr. Hagge's amended tax forms for the years 1985 through 1988 for refunds, according to Gary Streit, Mr. Hagge's attorney. The state claimed that the Supreme Court ruling is not retroactive.

After the revenue department rejected his amended tax forms, Mr. Hagge in September 1991 filed a petition for review in district court, requesting a reversal of the state revenue department's order.

Mr. Cook said the issue of paying the refunds retroactively probably will be settled in the U.S. Supreme Court before the Iowa Supreme Court hears the case. The nation's high court has agreed to hear arguments in a Virginia retroactivity case during its fall term.

In that case, the U.S. Supreme Court will decide whether the state of Virginia must pay more than $400 million in refunds to federal retirees who were taxed unconstitutionally.

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