WASHINGTON - The Supreme Court on Friday ruled against Virginia in a high-profile tax case, but stopped short of ordering the state to provide refunds to federal retirees who had successfully challenged the constitutionality of taxes assessed on their pensions.

In a 7-to-2 opinion delivered by Justice Clarence Thomas, the justices said that although they were reversing a ruling by the Virginia Supreme Court that held no tax refunds were necessary, "We do not enter judgment for petitioners because ... federal law does not necessarily entitle [the retirees] to a refund.

"Rather, the Constitution requires Virginia to provide relief consistent with federal due process principles," Thomas said.

Thomas said that under the Constitution's due process clause, states have "flexibility" in responding to judicial findings that they have illegally collected taxes.

For example, Thomas said, "If Virginia offers a meaningful opportunity or taxpayers to withhold contested tax assessments and to challenge their validity in a predeprivation hearing, the availability of a predeprivation hearing constitutes a procedural safeguard ... sufficient itself to satisfy the due process clause."

However, Thomas said, if Virginia does not have an adequate forum for taxpayers to object to their taxes before paying them, the state would be obligated "to provide meaningful backward-looking relief to rectify any unconstitutional deprivation."

Thomas said that even under that scenarto, states retain some wiggle room. For example, he said, "a state may either award full refunds to those burdened by an unlawful tax or issue some other order that creates in hindsight a nondiscriminatory scheme."

Because the case, Harper v. Virginia Department of Taxation, had not revolved around the issue of whether the state has provided an adequate avenue of protest for taxpayers, the court majority said "we leave to Virginia courts this question of state law and the performance of other tasks pertaining to the crafting of any appropriate remedy."

Paul W. Timmreck, Virginia's finance secretary, said the court's disposition of the case was "one of the best possible opinions we could have." Timmreck, stressing that he had not yet had an opportunity to study the decision, said the court's determination that refunds are not necessarily required is "encouraging to us."

Virginia faces a potential refund liability from the case of $467 million. But the impact of the court's ruling may be felt across the country. In Iowa, for example, officials are reviewing the decision for implications on a case that could cost the state as much as $50 million in retroactive state income tax refunds to federal government pensioners. The state appealed the case to the Iowa high court, which could issue a ruling in July or August, according to Carl Castelda, deputy director of the state revenue department.

In Wisconsin, the state Tax Appeals Commission last month ruled that the state owes federal retirees about $100 million in state income tax refunds, according to Mark Bugher, the state's revenue secretary.

Bugher said that Wisconsin on Friday appealed the commission's decision to the Dane County Circuit Court in an attempt to determine, among other things, whether the U.S. Supreme Court decision applies to the Wlsconsin case.

The State and Local Legal Center, which files friend-of-the-court briefs on behalf of municipalities, has estimated the total refund liability of states that had similar taxing schemes at $2 billion.

Richard Ruda, chief counsel of the legal center, said that given the fact the justices were disposed to require retroactive application of their decisions, "the fact that they have left open the issue of remedy to state law in state courts is probably as fair a resolution as we could hope for. It's better than a ruling that Virginia and all other states that had similar systems have to make full refunds tomorrow."

The Harper dispute arose in the aftermath of a 1989 Supreme Court ruling in Davis v. Michigan. In that case, the court said states may not tax federal retirement pay while exempting from taxation the pensions of former state workers. The ruling set off a wave of refund requests in Virginia and the 21 other states that had practices similar to Michigan's.

Henry Harper and other federal retirees in Virginia sought refunds following the Davis ruling. But the Virginia Supreme Court ruled in 1991 that the Davis ruling should be applied prospectively, not retroactively, and that as a consequence no refunds were necessary.

Later that year, however, the U. S. Supreme Court said that, in general, its decisions should be considered retroactively. The splintered ruling, issued in James B. Beam Distilling Co. v. Georgia, prompted Harper to appeal to the U.S. high court, which ordered its Virginia counterpart to reconsider the matter in light of the Beam ruling.

The Virginia Supreme Court again found that no refunds were necessary, prompting Harper to again petition the U.S. Supreme Court for review. The justices agreed to take the case and heard oral arguments in December.

Part of the problem confronting the high court in deciding the Harper case was uncertainty surrounding its Beam ruling. While a majority on the court decided that Georgia had to refund unconstitutional taxes collected on liquor, the justices did not agree on why the refund was necessary.

Failing into three factions, several justices said that once the court has applied a rule of law to litigants in one case, it must do so in similar cases. Other justices said refunds should be required in all cases in which taxes were collected unconstitutionally.

Three justices in dissent argued that when the court announces a new rule of law, refund liability should be determined by a three-factor formula examining: whether the state should have foreseen that its tax would be declared unconstitutional, whether the Constitution's ban on state discrimination against interstate commerce would be furthered by retroactive relief, and whether requiring a refund would produce inequitable results.

In Friday's opinion. the justices cleared up the confusion. "We hold that this court's application of a rule of federal law to the parties before the court requires every court to give retroactive effect to that decision," Thomas said.

Nevertheless, the ruling spawned disagreement. Justice Anthony Kennedy said he remains "of the view that it is sometimes appropriate in the civil context to give only prospective application to ajudicial decision."

But he said that the Harper case was not such an instance. He said, "This court is not free to mitigate any financial hardship that might befall Virginia's taxpayers as a result of their state government's failure to reach a correct understanding of the unambiguous dictates of federal law. "

In a blistering 25-page dissent, Justice Sandra Day O'Connor castigated the majority for imposing a "crushing and unnecessary liability on the states, precisely at a time when they can least afford it."

O'Connor also took the position that, rather than clarifying the retroactivity issue, the court's ruling injects "still greater uncertainty and disorder into [an] already chaotic area. Because I cannot agree with the court's decision or the manifestly unjust results it appears to portend, I respectfully dissent."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.