Katzenberg v. Comptroller of the Treasury

Singley, J., delivered the opinion of the Court. The appellants here challenge the validity of certain portions of Chapter 142 of the Laws of 1967, Maryland Code (1957, 1969 Repl. Vol.) Art. 81, §§ 279-283, 287-289, 323-323A (the Act), which substantially revised Maryland’s income tax law. While the Act became effective 1 July 1967, it was, by its terms, applicable to income received after 31 December 1966.

Maryland had imposed income taxes in a desultory fashion from 1777 through 1779 and from 1841 until 1849, but had no general income tax again until the enactment of Chapter 11, § 8 of the Laws of 1937 (Special Session) (the 1937 Act), Cairns, History and Constitutionality of the Maryland Income Tax Law, 2 Md. L. ¹⁹² Rev. 1 (1937). The tax imposed by the 1937 Act was classified (i.e., not graduated), but later amendments taxed earned and investment income at different rates. Broadly speaking, the 1937 Act set up a scheme of exemptions, exclusions, and deductions which was similar to, but not identical with, that contained in the Internal Revenue Code. Although originally only gains from the disposition of property held more than two years were exempt, generally speaking, capital gains were not taxed as such by the 1937 Act, nor was the deduction of capital losses permitted, Carter, A Survey of the Maryland, Income Tax Law, 2 Md. L. Rev. 11 (1937).

Although the 1937 Act was modified and amended from time to time, the basic philosophy of the 1937 Act persisted until 1967. Chapter 142 of the Laws of 1967 completely restructured Maryland’s income tax law, by adopting as a base for State income tax purposes the adjusted gross income of an individual taxpayer (§ 280 (a)) and the taxable income of a corporate taxpayer (§ 280A), as determined under the Internal Revenue Code, to and from which certain amounts, as specified by the Act, are to be added or deducted. On the resulting figure, § 288 of the Act imposes a graduated tax ranging from 2 % to 5% for individuals, and a non-graduated tax for corporations. The scheme of exemptions, exclusions and deductions contained in the 1937 Act, as amended, was retained with modifications.

For the purposes of this opinion, the important change brought about by the Act was that for the first time capital gains and losses were brought within the ambit of the State income tax. This is so because gains and losses are reflected in the adjusted gross income of an individual and the taxable income of a corporation developed for federal tax purposes, to which the Maryland tax is applied. The appellants here are Morton C. Katzenberg and Dena S. Katzenberg, his wife, and David M. Katzenberg ¹⁹³ and Steven A. Katzenberg, their sons, sometimes referred to collectively hereafter as “the Katzenbergs”. In 1962, the Katzenbergs, each of whom owned shares of the capital stock of The Farboil Company (Farboil), entered into agreements with Farboil under which their stock was sold to that company for a consideration consisting of promissory notes payable in 25 equal annual installments with interest at 4 %, or similar notes with interest at 5 % and cash, as follows: Notes Cash Morton C. Katzenberg $107,441.71 - Dena S. Katzenberg 215,851.37 - David M. Katzenberg 53.519.80 $2,229.99 Steven A. Katzenberg 47.759.80 1,989.99 In 1963, Morton C. Katzenberg entered into an agreement for the sale of all stock of The Haven Chemical Company (Haven) owned by him, for which he received two notes payable in 10 equal installments with interest at 4%, totaling $47,277.16.

In 1964, Dena S. Katzenberg sold her one-third interest in the co-partnership known as Quail Realty (Quail) to the two remaining partners, for which she received the partners’ promissory note for $63,126.47, due one year from date with interest at 5]/2 % • It would appear to be conceded that each of these transactions was designed to qualify for installment sale treatment under § 453 of the Internal Revenue Code, but that because Mr. and Mrs. Katzenberg were in high federal income tax brackets, they derived no tax benefit from such treatment, and that only minimal benefits were enjoyed by their two sons. All of them did, however, achieve the advantage of postponing payment of the capital gains tax until there were funds in hand from which it could be paid. It was what happened later that gave rise to this controversy : Farboil. Farboil paid the installments due on its notes ¹⁹⁴ in 1963, 1964, 1965, 1966 and 1967.

As a result of the acquisition of Farboil by another company in 1968, the unpaid principal balances, by the terms of the notes, became due and payable, and the capital gains attributable to the amounts received by the four Katzenbergs were reflected in their 1968 federal income tax returns. Haven. Haven paid the installments due on its notes in 1964, 1965, 1966 and 1967. By agreement, the payment of the unpaid principal balance was accelerated in 1968, and of the amount received in that year, the sum of $39,835 was reflected as a capital gain in the joint federal tax return of Morton C. and Dena S. Katzenberg.

Quail. Payments in reduction of the Quail note were made in 1964, 1965 and 1966. In 1967 the unpaid balance of $20,000 and accrued interest was paid to Mrs. Katzenberg and the portion of this payment representing capital gain was reflected in the joint 1967 federal tax return of Morton C. and Dena S. Katzenberg. As a consequence of the recognition of the capital gains for federal income tax purposes in 1967 and 1968, the Katzenbergs incurred Maryland income tax liabilities in those years, aggregating $15,085.00, as follows: 1967 1968 $625.00 $11,953.00 Morton C. and Dena S. Katzenberg 35.00 1,241.00 David M. Katzenberg 34.00 1,197.00 Steven A. Katzenberg $694.00 $14,391.00 It was these amounts, together with interest at 6 % from 15 April 1968 and 1969, which were the subject of claims for refund, filed with the State Comptroller.

When the claims were denied, the Katzenbergs appealed to the Maryland Tax Court, which affirmed the Comptroller. An appeal was taken to the Baltimore City Court, and from an order of that court affirming the action of the tax court, this appeal was taken. ¹⁹⁵ The Katzenbergs advance five reasons why the order of the Baltimore City Court should be reversed: “1. The application of the 1967 capital gains tax act to payments under installment agreements entered into years before its consideration and effectiveness is invalid by reason of the excessive backward reach of the tax and by reason of the inapplicability of all of the recognized exceptions to the constitutional rule of nonretroactivity. “2. The retroactive application of the tax to these taxpayers is unconstitutionally arbitrary insofar as it makes Maryland tax liability depend on exercise of optional reporting methods, years previously, under a different taxing scheme, rather than on the substance of transactions. “3.

The application of the tax is invalid and unconstitutional by reason of the fact that it is made to fall upon capital gains accruing during periods beginning in 1932, 1952, and 1951 and ending in 1962, 1963, and 1964 and fully realized by receipt of full and alienable consideration in the form of notes years prior to consideration and enactment of the tax. “4. A graduated retroactive capital gains tax with exceptions is a direct tax on property subject to and contravening the uniformity provisions of Article 15 of the Maryland Declaration of Rights. “5. The adoption by the 1967 Act of principles of construction applicable to the federal income tax law as well as the principle that statutes are to be construed to avoid constitutional problems require that Chapter 142 be held inapplicable to the transactions in suit.” Before considering these contentions, seriatim, it might be helpful to recall certain basic principles. Traditionally, state income tax laws have been attacked on the ground that they failed to respond to the constitutional mandates of equality or uniformity, Cairns, supra at 5.

This has been most recently exemplified by the result reached by the Supreme Court of Pennsylvania in Amidon v. Kane, 444 Pa. 38 , 279 A. 2d 53 (1971) which struck down the individual income tax imposed by Arti ¹⁹⁶ ele III of the Commonwealth’s Tax Reform Code of 1971, Act No. 2, 72 P.S. § 7107 et seq., largely because it was violative of the requirement contained in Art. VIII, § 1 of the Constitution of Pennsylvania that “[a] 11 taxes be uniform, upon the same class of subjects, * * *” following Saulsbury v. Bethlehem Steel Co., 413 Pa. 316 , 196 A. 2d 664 (1964) and Kelley v. Kalodner, 320 Pa. 180 , 181 A. 598 (1935). 1 The rub comes from the fact that not every constitutional mandate of uniformity applies to all taxes, 1 Cooley, The Law of Taxation § 267 (4th ed. 1924). The controlling provision in Maryland is found in Article 15 of the Declaration of Rights: “That the levying of taxes by the poll is grievous and oppressive and ought to be prohibited ; that paupers ought not to be assessed for the support of the government; that the General Assembly shall, by uniform rules, provide for the separate assessment, classification and sub-classification of land, improvements on land and personal property, as it may deem proper; and all taxes thereafter provided to be levied by the State for the support of the general State Government, and by the Counties and by the City of Baltimore for their respective purposes, shall be uniform within each class or sub-class of land, improvements on land and personal property which the respective taxing powers may have directed to be subjected to the tax levy; yet fines, duties or taxes may properly and justly be imposed, or laid with a political view for the good government and benefit of the community.” 2 ¹⁹⁷ Whatever doubts may have existed in respect to the scope of the uniformity requirement of Article 15 have long been resolved by the cases holding that the requirement of uniformity is directed at property taxes, and that an income tax is not a property tax, Rafferty v. Comptroller, 228 Md. 153, 161 , 178 A. 2d 896 (1962); Oursler v. Tawes, 178 Md. 471 , 13 A. 2d 763 (1940); Tyson v. State, 28 Md. 577 (1868). It seems equally well settled that exemptions, made for a public purpose and uniformly applied, are permissible under Article 15. Compare Murray v. Comptroller of the Treasury, 241 Md. 383 , 216 A. 2d 897 (1966) and Wells v. Commissioners of Hyattsville, 77 Md. 125 , 26 A. 357 (1893) with Baltimore v. Starr Methodist Protestant Church, 106 Md. 281 , 67 A. 261 (1907).

Similarly, the requirement of equality does not apply to “taxes * * * laid with a political view” under the last clause of Article 15, Oursler v. Tawes, supra at 485-86; Niles, Maryland Constitutional Law 32-33 (1915); Lewis, The Tax Articles of the Maryland Declaration of Rights, 13 Md. L. Rev. 83 , 110-11 (1953). One of the more enigmatic facets of this case upon which neither of the parties relies is that by Chapter 656, § 1 of the Laws of 1968, Art. 81, § 280 (c) (which enumerates the items which are to be subtracted by an individual taxpayer from federal adjusted gross income for purposes of determining the base on which Maryland income tax is to be computed) was amended by providing for the subtraction of the following: “* * * (6) For taxable years beginning after December 31, 1968, the amount of capital gains included therein which was realized from the sale, exchange or other disposition of property ¹⁹⁸ prior to January 1, 1967, which was not includable in ‘gross income’ under § 280 (A) of Article 81 of Annotated Code of Maryland in effect on the date of realization of said gain or gains.” Section 2 of the same Law provided, “[t]hat all provisions of this Act, being clarification of the intent of Chapter 142, Acts of 1967, or of prior law shall apply to all taxable years ending after December 31, 1966.” In the immediately succeeding Session of the General Assembly, Chapter 376 of the Laws of 1969 repealed and re-enacated Art. 81, § 280 (c), eliminating the provision of Chapter 656 of the Laws of 1968 quoted above, and provided that the 1969 Act would take effect on 1 July 1969. Whatever may have been the purpose of this maneuver, it would seem palpably clear that it was the legislative intent that capital gains should be included in the base on which Maryland income tax was to be paid. This was the conclusion reached by the Attorney General: “When it enacted Chapter 142, the State Legislature deliberately and intentionally pronounced a doctrine of conformance between the State income tax law and the federal income tax law.

In so doing, it adopted the federal base for determining gross income, and it included capital gains and losses taxed as under federal laws, but at State rates. This is clearly established by the ‘Report of the Committee on Taxation and Fiscal Reform’ (February 1, 1967), which Committee was appointed by Governor-Elect Agnew on December 7, 1966 to present the implementing legislation for consideration by the General Assembly at its 1967 Session.” 52 Op. Att’y Gen. 451, 452 (1967). We now turn to a consideration of the several contentions made by the Katzenbergs. ¹⁹⁹ G) “The application of the tax to these installment agreements is within none of the recognized exceptions to the constitutional rule of non-retro-activity.” In Comptroller v. Glenn L. Martin Co., 216 Md. 235 , 140 A. 2d 288 (1958), we had occasion to consider the validity of Chapter 3 of the Laws of 1957, purporting to make retroactive to 1947 an amendment to the sales and use tax acts which had the effect of subjecting to such taxes certain facilities purchased by the Martin Company in 1951-1954 under agreements which required immediate resale to the federal government.

There, while we struck down the challenged