Registration of Municipal, State Bonds Upheld

The Supreme Court today upheld a law requiring municipal or state bonds issued after June 30, 1983, to be registered before they can be tax-exempt.

The justices, by a 7-1 vote, ruled that the federal law enacted to discourage tax evasion in the trading of municipal bonds does not violate any state’s sovereign immunity.

South Carolina had challenged the law, arguing that the law will hurt state and local governments by forcing them to choose between two costly alternatives: continue to issue unregistered bonds for which investors will have their interest taxed or pay sizable registration fees.

State Position Backed

State and local governments issue bonds to finance various projects such as building roads and schools.

More than half the states had supported South Carolina’s challenge.

The law, which took effect July 1, 1983, is aimed in part at discouraging tax evasion when bonds change hands as gifts or are passed on to an heir. While the interest on government bonds is exempt from federal income tax, the bonds are taxed as gifts or as part of an estate.

In passing the law, Congress mainly intended to crack down on the use of such bonds as an untraceable substitute for cash in illegal activities, and to make it easier to catch criminals who deal in stolen or forged securities.

Only One Dissent

Writing for the court today, Justice William J. Brennan said, “A nondiscriminatory federal tax on the interest earned on state bonds does not violate the intergovernmental tax immunity doctrine.”

Only Justice Sandra Day O’Connor dissented, accusing the court of overturning “a precedent that it has honored for nearly a hundred years” by making state and municipal bonds subject to possible federal taxation.

“Henceforth the ability of state and local governments to finance their activities will depend in part on whether Congress voluntarily abstains from tapping this permissible source of additional income-tax revenue.”

Justice Anthony M. Kennedy did not participate in the case, which is called South Carolina vs. Baker, 94 Original.