JUSTICES MULL LANDMARK DECISION
ON OUT-OF-STATE BONDS

Bond investors are anxiously awaiting word on whether the Supreme Court will consider what could be a landmark case from Kentucky.

The lawsuit, Kentucky v. Davis, focuses on whether a state can require investors to pay taxes on out-of-state bonds while exempting in-state debt.

The court had been expected to decide whether to take up the case in February. Some now speculate the court’s silence may indicate that justices are in the midst of preparing an opinion.

Constitutional question

Most states currently require residents to pay taxes on municipal bonds issued in other states, but not on bonds originating in an investor’s state of residence.

In Kentucky, local and state courts had upheld the contention by investors that such laws violate the U.S. constitutional provision that only Congress has the jurisdiction to interfere with trade between states.

Kentucky’s Supreme Court had declined to hear an appeal of that decision, and it is uncertain whether the U.S. Supreme Court will choose to hear the case.

Two options

Attorneys with Ackerman Senterfitt, a law firm with a large public finance practice, say a decision in favor of investors would leave states with two choices: either subject all municipal bonds to state tax, or eliminate the current system of taxing out-of- state bonds.

Ackerman believes states may choose to tax their own bonds rather than give up the revenue they are currently collecting. Such a decision, in Ackerman’s view, would also eliminate the advantage of state-specific municipal bond funds. At the same time, states in which issuance is high would lose the benefit they currently enjoy with home-state investors.

Tax-free bond investors would benefit from such a decision because the market for municipal bonds would be nationalized, providing greater choice for bond purchasers by creating a level playing field.

A decision favoring Kentucky would mean business as usual in the tax-free bond market.

We’ll keep you posted.

5/18/07