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Tax Cases

The Supreme Court generally hears a tax case or two each term. This time it chose taxes liens, time of tax payment, and state franchise tax. We review them in that order.

1. Does a disclaimer avoid a tax Lien agains the disclaiming heir?

For those who think that a case which combines estates and taxes is dry, think again. It is Drye. Drye’s story is a tale of woe. When Drye looked for money he came up dry. Drye was so broke that he owed taxes he couldn’t pay. Lots of taxes. Then Drye’s mother died. The loss of his mother was somewhat offset by Drye’s inheritance of his mother’s fortune. Or so it seemed at first. Unfortunately, his misfortune exceeded his mother’s fortune and the IRS might take it all. Mr. Drye was a generous man, but not that generous. The object of his bounty was his daughter. Drye disclaimed his mother’s inheritance. Thus, her estate passed as if he had predeceased his mother, leaving nothing for the IRS to reach. Or so it seemed. Drye was not the only generous person in his family. His daughter, perhaps inspired by his selfless act, conveyed the inheritance to a trust. Yes, a spendthrift trust which provided discretionary distributions to her father. A trustee was needed. Drye’s lawyer took the job. What a splendid plan it was! Precedent from the Fifth and Ninth Circuits supported Drye. Yet, the IRS, unimpressed by this court authority and family generosity to all except itself, sought to take the fortune just as if Drye owned it. Drye, continuing his run of bad luck, lived in the wrong place, Arkansas, within the Eighth Circuit, instead of neighboring states within the Fifth. The Eighth Circuit upheld the IRS view, creating a split between the circuits. The Supreme Court resolves the split decisions in Drye.

Drye v. US

      On December 7, 1999 Justice Ginsburg delivered the opinion for a unanimous Court.

      This case concerns the respective provinces of state and federal law in determining what is property for purposes of federal tax lien legislation. At the time of his mother's death, petitioner Rohn F. Drye, Jr., was insolvent and owed the Federal Government some $325,000 on unpaid tax assessments for which notices of federal tax liens had been filed. His mother died intestate, leaving an estate with a total value of approximately $233,000 to which he was sole heir. After the passage of several months, Drye disclaimed his interest in his mother's estate, which then passed by operation of state law to his daughter. This case presents the question whether Drye's interest as heir to his mother's estate constituted "property" or a "righ[t] to property"  to which the federal tax liens attached under 26 U. S. C. §6321, despite Drye's exercise of the prerogative state law accorded him to disclaim the interest retroactively.

We hold that the disclaimer did not defeat the federal tax liens. The Internal Revenue Code's prescriptions are most sensibly read to look to state law for delineation of the taxpayer's rights or interests, but to leave to federal law the determination whether those rights or interests constitute "property" or "rights to property" within the meaning of §6321. "[O]nce it has been determined that state law creates sufficient interests in the [taxpayer] to satisfy the requirements of [the federal tax lien provision], state law is inoperative to prevent the attachment of liens created by federal statutes in favor of the United States." [1]

     The relevant facts are not in dispute. On August 3, 1994, Irma Deliah Drye died intestate, leaving an estate worth approximately $233,000, of which $158,000 was personalty and $75,000 was realty located in Pulaski County, Arkansas. Petitioner Rohn F. Drye, Jr., her son, was sole heir to the estate under Arkansas law.[2] On the date of his mother's death, Drye was insolvent and owed the Government approximately $325,000, representing assessments for tax deficiencies in years 1988, 1989, and 1990. The Internal Revenue Service (IRS or Service) had made assessments against Drye in November 1990 and May 1991 and had valid tax liens against all of Drye's "property and rights to property" pursuant to 26 U. S. C. §6321.

Drye petitioned the Pulaski County Probate Court for appointment as administrator of his mother's estate and was so appointed on August 17, 1994. Almost six months later, on February 4, 1995, Drye filed in the Probate Court and land records of Pulaski County a written disclaimer of all interests in his mother's estate. Two days later, Drye resigned as administrator of the estate.

     Under Arkansas law, an heir may disavow his inheri-

tance by filing a written disclaimer no later than nine months after the death of the decedent.[3] The disclaimer creates the legal fiction that the disclaimant predeceased the decedent; consequently, the disclaimant's share of the estate passes to the person next in line to receive that share. The disavowing heir's creditors, Arkansas law provides, may not reach property thus disclaimed.[4] In the case at hand, Drye's disclaimer caused the estate to pass to his daughter, Theresa Drye, who succeeded her father as administrator and promptly established the Drye Family 1995 Trust (Trust).

      On March 10, 1995, the Probate Court declared valid Drye's disclaimer of all interest in his mother's estate and accordingly ordered final distribution of the estate to Theresa Drye. Theresa Drye then used the estate's proceeds to fund the Trust, of which she and, during their lifetimes, her parents are the beneficiaries. Under the Trust's terms, distributions are at the discretion of the trustee, Drye's counsel Daniel M. Traylor, and may be made only for the health, maintenance, and support of the beneficiaries. The Trust is spendthrift, and under state law, its assets are therefore shielded from creditors seeking to satisfy the debts of the Trust's beneficiaries.

     Also in 1995, the IRS and Drye began negotiations regarding Drye's tax liabilities. During the course of the negotiations, Drye revealed to the Service his beneficial interest in the Trust. Thereafter, on April 11, 1996, the IRS filed with the Pulaski County Circuit Clerk and Recorder a notice of federal tax lien against the Trust as Drye's nominee. The Service also served a notice of levy on accounts held in the Trust's name by an investment bank and notified the Trust of the levy.

B

On May 1, 1996, invoking 26 U. S. C. §7426(a)(1), the Trust filed a wrongful levy action against the United States in the United States District Court for the Eastern District of Arkansas. The Government counterclaimed against the Trust, the trustee, and the trust beneficiaries, seeking to reduce to judgment the tax assessments against Drye, confirm its right to seize the Trust's assets in collection of those debts, foreclose on its liens, and sell the Trust property. On cross-motions for summary judgment, the District Court ruled in the Government's favor.

     The United States Court of Appeals for the Eighth Circuit affirmed the District Court's judgment.[5] The Court of Appeals understood our precedents to convey that "state law determines whether a given set of circumstances creates a right or interest; federal law then dictates whether that right or interest constitutes `property' or the `right to property' under §6321."[6]

     We granted certiorari, 526 U. S. __ (1999), to resolve a conflict between the Eighth Circuit's holding and decisions of the Fifth and Ninth Circuits.#[7] We now affirm.

II

     Under the relevant provisions of the Internal Revenue Code, to satisfy a tax deficiency, the Government may impose a lien on any "property" or "rights to property" belonging to the taxpayer. Section 6321 provides: "If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount ... shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person."[8] A complementary provision, §6331(a), states:

     "If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax ... by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in this chapter for the payment of such tax." #[9]

     The language in §§6321 and 6331(a), this Court has observed, "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have."[10] When Congress so broadly uses the term "property," we recognize, as we did in the context of the gift tax, that the Legislature aims to reach " `every species of right or interest protected by law and having an exchangeable value.' " [11]

     Section 6334(a) of the Code is corroborative. That provision lists property exempt from levy. The list includes 13 categories of items; among the enumerated exemptions are certain items necessary to clothe and care for one's family, unemployment compensation, and workers' compensation benefits.[12] The enumeration contained in §6334(a), Congress directed, is exclusive: "Notwithstanding any other law of the United States ..., no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a)." §6334(c). Inheritances or devises disclaimed under state law are not included in §6334(a)'s catalog of property exempt from levy. [13]The absence of any recognition of disclaimers in §§6321, 6322, 6331(a), and 6334(a) and (c), the relevant tax collection provisions, contrasts with §2518(a) of the Code, which renders qualifying state-law disclaimers "with respect to any interest in property" effective for federal wealth-transfer tax purposes and for those purposes only. #[14]

     Drye nevertheless refers to cases indicating that state law is the proper guide to the critical determination whether his interest in his mother's estate constituted "property" or "rights to property" under §6321. His position draws support from two recent appellate opinions.[15] Although our decisions in point have not been phrased so meticulously as to preclude Drye's argument, #[16] we are satisfied that the Code and interpretive case law place under federal, not state, control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes.

III

     As restated in National Bank of Commerce : "The question whether a state-law right constitutes `property' or `rights to property' is a matter of federal law."[17]We look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation. [18]

     In line with this division of competence, we held that a taxpayer's right under state law to withdraw the whole of the proceeds from a joint bank account constitutes "property" or the "righ[t] to property" subject to levy for unpaid federal taxes, although state law would not allow ordinary creditors similarly to deplete the account.[19] And we earlier held that a taxpayer's right under a life insurance policy to compel his insurer to pay him the cash surrender value qualifies as "property" or a "righ[t] to property" subject to attachment for unpaid federal taxes, although state law shielded the cash surrender value from creditors' liens. [20]#[21] By contrast, we also concluded, again as a matter of federal law, that no federal tax lien could attach to policy proceeds unavailable to the insured in his lifetime.[22] #[23]

     Just as "exempt status under state law does not bind the federal collector,"[24] so federal tax law "is not struck blind by a disclaimer,"[25] Thus, in Mitchell , the Court held that, although a wife's renunciation of a marital interest was treated as retroactive under state law, that state-law disclaimer did not determine the wife's liability for federal tax on her share of the community income realized before the renunciation. See 403 U. S., at 204 (right to renounce does not indicate that taxpayer never had a right to property).

IV

     The Eighth Circuit, with fidelity to the relevant Code provisions and our case law, determined first what rights state law accorded Drye in his mother's estate. It is beyond debate, the Court of Appeals observed, that under Arkansas law Drye had, at his mother's death, a valuable, transferable, legally protected right to the property at issue.[26] The court noted, for example, that a prospective heir may effectively assign his expectancy in an estate under Arkansas law, and the assignment will be enforced when the expectancy ripens into a present estate. [27]#[28]

     Drye emphasizes his undoubted right under Arkansas law to disclaim the inheritance,[29] a right that is indeed personal and not marketable.[30] But Arkansas law primarily gave Drye a right of considerable value--the right either to inherit or to channel the inheritance to a close family member (the next lineal descendant). That right simply cannot be written off as a mere "personal right ... to accept or reject [a] gift." Brief for Petitioners 13.

     In pressing the analogy to a rejected gift, Drye overlooks this crucial distinction. A donee who declines an inter vivos gift generally restores the status quo ante , leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property--himself if he does not disclaim, a known other if he does.[31] This power to channel the estate's assets warrants the conclusion that Drye held "property" or a "righ[t] to property" subject to the Government's liens.

* * *

     In sum, in determining whether a federal taxpayer's state-law rights constitute "property" or "rights to property," "[t]he important consideration is the breadth of the control the [taxpayer] could exercise over the property."[32] Drye had the unqualified right to receive the entire value of his mother's estate (less administrative expenses),[33] or to channel that value to his daughter. The control rein he held under state law, we hold, rendered the inheritance "property" or "rights to property" belonging to him within the meaning of §6321, and hence subject to the federal tax liens that sparked this controversy.

2. When do you pay taxes? What tax is withheld or estimated? What if you overpay, but don’t file? When can’t you get a refund?

What happens if you overpay you income tax and seek a refund? Will the government give back your money that you didn’t owe? Will they say, “too late, we have it, you lose?” They might. If you don’t seek a refund by the deadline, IRS has you over a barrel. The deadline depends on when you pay. When is a payment a payment, you ask? Mr. Baral and the IRS disagreed.

BARAL v. UNITED STATES

On February 22, 2000 Justice Thomas delivered the opinion of the Court.

Internal Revenue Code §6511(b)(2)(A) imposes a ceiling on the amount of credit or refund to which a taxpayer is entitled as compensation for an overpayment of tax: "[T]he amount of the credit or refund shall not exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to 3 years plus the period of any extension of time for filing the return."[34] We are called upon in this case to decide when two types of remittance are "paid" for purposes of this section: a remittance by a taxpayer of estimated income tax, and a remittance by a taxpayer's employer of withholding tax. The plain language of a nearby Code section, §6513(b), provides the answer: These remittances are "paid" on the due date of the taxpayer's income tax return.

I

The relevant facts are not disputed. Two remittances were made to the Internal Revenue Service toward petitioner David H. Baral's income tax liability for the 1988 tax year. The first, a withholding of $4,104 from Baral's wages throughout 1988, was a garden-variety collection of income tax by the employer.[35] The second, an estimated income tax of $1,100 remitted in January 1989, was sent by Baral himself out of concern that his employer's withholding might be inadequate to meet his tax obligation for the year, see §6654. In the ordinary course, Baral's income tax return for 1988 was due to be filed on April 15, 1989. Though he applied for and received an extension of time until August 15, Baral missed this deadline; he did not file the return until nearly four years later, on June 1, 1993. The Service, on July 19, 1993, assessed the tax liability reported on this belated return.

On the return, Baral claimed that he (and his employer on his behalf) had remitted $1,175 more with respect to the 1988 taxable year than he actually owed. Baral requested that the Service apply this excess as a credit toward his outstanding tax obligations for the 1989 taxable year. The Service denied the requested credit. It did not dispute that Baral had timely filed the request under the relevant filing deadline--"within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later."[36] But the Service concluded that the claim exceeded the ceiling imposed by §6511(b)(2)(A). That provision states that "the amount of the credit or refund shall not exceed the portion of the tax paid within the period, immediately preceding the filing of the claim, equal to 3 years plus the period of any extension of time for filing the return."[37] Since Baral had filed his return on June 1, 1993, and had earlier received a 4-month extension from the initial due date, the relevant look-back period under §6511(b)(2)(A) extended from June 1, 1993, back to February 1, 1990 ( i.e., three years plus four months). According to the Service, Baral had paid no portion of the overpaid tax during that period, and so faced a ceiling of zero on any allowable refund or credit.

Baral then commenced the instant suit for refund in Federal District Court. That court sustained the Service's position and granted summary judgment in its favor. The Court of Appeals affirmed.[38] The Court of Appeals looked to §6513(b)(1), which states that amounts of tax withheld from wages "shall ... be deemed to have been paid by [the taxpayer] on the 15th day of the fourth month following the close of his taxable year," and to §6513(b)(2), which makes similar provision for amounts submitted as estimated income tax, and concluded that, under these subsections, both of the remittances at issue were "paid" on April 15, 1989.[39] In view of apparent tension between this approach and a decision of the Court of Appeals for the Fifth Circuit,[40] we granted certiorari.[41]

II

     The parties renew before us the contentions advanced below. The Government submits that §§6513(b)(1) and (2) unequivocally provide that the two remittances at issue were "paid" on April 15, 1989 for purposes of §6511(b)(2)(A), so that they precede the look-back period, which, as noted, commenced on February 1, 1990. Baral, on the other hand, urges that a tax cannot be "paid" within the meaning of §6511(b)(2)(A) until the tax liability is assessed ( i.e., the value of the liability is definitively fixed). According to Baral, the requisite assessment might be made either when the taxpayer files his return (here June 1, 1993) or when the Service, under §6201, formally assesses the liability (here July 19, 1993), though he seems to prefer the latter date.[42]

We agree with the Government that §6513(b)(1) and (2) settle the matter. We set out these provisions in full:

"(b) Prepaid Income Tax

"For purposes of section 6511 or 6512--

(1) Any tax actually deducted and withheld at the source during any calendar year under chapter 24 shall, in respect of the recipient of the income, be deemed to have been paid by him on the 15th day of the fourth month following the close of his taxable year with respect to which such tax is allowable as a credit under section 31.

"(2) Any amount paid as estimated income tax for any taxable year shall be deemed to have been paid on the last day prescribed for filing the return under section 6012 for such taxable year (determined without regard to any extension of time for filing such return)."

Subsection (1) resolves when the remittance of withholding tax by Baral's employer was "paid": Since Baral is a calendar year taxpayer, the $4,104 withheld from his wages during the 1988 calendar year was "paid" on April 15, 1989. Subsection (2) determines when Baral's remittance of estimated income tax was "paid": Since the referenced §6012 together with §6072(a) require that a calendar year taxpayer like Baral file his income tax return on the April 15th following the close of the calendar year, the $1,100 remitted as an estimated income tax in respect of Baral's 1988 tax liability was likewise "paid" on April 15, 1989. And both of these statutorily defined payment dates apply "[f]or purposes of section 6511," the provision directly at issue in this case. This means that, under §6511(b)(2)(A), both remittances at issue (the withholding and the estimated income tax) fall before, and hence outside, the look-back period, which commenced on February 1, 1990. Because neither these remittances nor any others were "paid" within the look-back period (February 1, 1990, to June 1, 1993), the ceiling on Baral's requested credit of $1,175 is zero, and the Service was correct to deny the requested credit.

Baral disputes this reading of §6513(b). He claims that §§6513(b)(1) and (2) establish a "deemed paid" date for payment of estimated tax and withholding tax, but in no sense prescribe when the income tax is "paid," which is the crucial inquiry under §6511(b)(2)(A). According to Baral, withholding tax and estimated tax are taxes in their own right (separate from the income tax), and are converted into income tax only on the income tax return. (On this view, payment of the income tax occurred no earlier than June 1, 1993, when Baral filed the return.) This reading is evident, he says, from the significance that the Treasury Regulations place on the filing of the return,[43] and from the fact that the Code's provisions regarding withholding and estimated tax are found in different subtitles (C and F, respectively) from the provisions governing income tax (A).

     We disagree. Withholding and estimated tax remittances are not taxes in their own right, but methods for collecting the income tax. Thus, §31(a)(1) of the Code provides that amounts withheld from wages "shall be allowed to the recipient of the income as a credit against the [income] tax," and §6315 states that "[p]ayment of the estimated income tax, or any installment thereof, shall be considered payment on account of the income taxes imposed by subtitle A for the taxable year." Similarly, one of the regulations cited by Baral explains that a remittance of estimated income tax "shall be considered payment on account of the income tax for the taxable year for which the estimate is made."[44] Baral's reading fails, moreover, to give any meaning to 26 U.S.C. §6513. That section exists "[f]or purposes of section 6511," and §6511 concerns credits and refunds, which result only when the aggregate of remittances (such as withholding tax and estimated income tax) exceed the tax liability, see §6401. Thus, the concepts of credit or refund have no meaning as applied to Baral's notion of withholding taxes and estimated taxes as freestanding taxes. Not surprisingly, the caption to §6513(b) describes withholding and estimated income tax remittances as "[p]repaid income tax."

     Taking a more metaphysical tack, Baral contends that income tax is "paid" under §6511(b)(2)(A) only when the income tax is assessed--here, June 1 or July 19, 1993,[45] --because the concept of payment makes sense only when the liability is "defined, known, and fixed by assessment," Brief for Petitioner 9. But the Code directly contradicts the notion that payment may not occur before assessment.[46] Nor does Baral's argument find support in our decision in Rosenman,[47] where we applied §6511's predecessor to a remittance of estimated estate tax. To be sure, a part of our opinion seems to endorse petitioner's view that payment only occurs at assessment:

"It is [the] erroneous assessment that gave rise to a claim for refund. Not until then was there such a claim as could start the time running for presenting the claim. In any responsible sense payment was then made by the application of the balance credited to the petitioners in the suspense account ... ." [48]

But the remittance in Rosenman, unlike the ones here, was not governed by a "deemed paid" provision akin to §6513, and we therefore had no occasion to consider the implications of such a provision for determining when a tax is "paid" under the predecessor to §6511.[49] Moreover, if the quoted passage had represented our holding, we would have broadly rejected the Government's argument that payment occurred when the remittance of estimated estate tax was made, instead of rejecting the argument, as we did, only because it was not in accord with the "tenor" of the "business transaction,"[50] #[51]

We observe, finally, that Baral's position--to the extent he submits that payment occurs only at the Service's assessment--would work to the detriment of taxpayers who timely file their returns and claim a refund or credit as compensation for an overpayment. The Service will not always assess the taxpayer's liability immediately upon receiving the return; the Service generally has three years in which to do so.[52] The Code does allow for payment of interest to the taxpayer on overpayments once the return has been filed and the tax paid, 26 U.S.C. §6611[53], but under Baral's view no interest could accrue during the time between the filing of the return and the Service's assessment. Fortunately for the timely taxpayer, the Code definitively rejects Baral's position in this setting. Section 6611(d) of 26 U.S.C. explains that the date of payment is determined according to the provisions of §6513, which, as noted,[54] plainly set a deemed date of payment for remittances of withholding and estimated income tax on the April 15 following the relevant taxable year.#[55]

3. Is the California franchise tax expense allocation between California activity and other activity constitutional?

Hunt-Wesson, Inc., v. Franchise Tax Board of California

On February 22, 2000, Justice Breyer delivered the opinion of the unanimous Court.

     A State may tax a proportionate share of the income of a nondomiciliary corporation that carries out a particular business both inside and outside that State.[56] The State, however, may not tax income received by a corporation from an " ` "unrelated business activity" ' which constitutes a ` "discrete business enterprise." ' ".[57] California's rules for taxing its share of a multistate corporation's income authorize a deduction for interest expense. But they permit (with one adjustment) use of that deduction only to the extent that the amount exceeds certain out-of-state income arising from the unrelated business activity of a discrete business enterprise, i.e., income that the State could not otherwise tax. We must decide whether those rules violate the Constitution's Due Process and Commerce Clauses. We conclude that they do.

I

     The legal issue is less complicated than may first appear, as examples will help to show. California, like many other States, uses what is called a "unitary business" income-calculation system for determining its taxable share of a multistate corporation's business income. In effect, that system first determines the corporation's total income from its nationwide business. During the years at issue, it then averaged three ratios--those of the firm's California property, payroll, and sales to total property, payroll, and sales--to make a combined ratio.[58] Finally, it multiplies total income by the combined ratio. The result is "California's share," to which California then applies its corporate income tax. If, for example, an Illinois tin can manufacturer, doing business in California and elsewhere, earns $10 million from its total nationwide tin can sales, and if California's formula determines that the manufacturer does 10% of its business in California, then California will impose its income tax upon 10% of the corporation's tin can income, $1 million.

     The income of which California taxes a percentage is constitutionally limited to a corporation's "unitary" income. Unitary income normally includes all income from a corporation's business activities, but excludes income that "derive[s] from unrelated business activity which constitutes a discrete business enterprise."[59] As we have said, this latter "nonunitary" income normally is not taxable by any State except the corporation's State of domicile (and the states in which the "discrete enterprise" carries out its business).[60]

     Any income tax system must have rules for determining the amount of net income to be taxed. California's system, like others, basically does so by asking the corporation to add up its gross income and then deduct costs. One of the costs that California permits the corporation to deduct is interest expense. The statutory language that authorizes that deduction--the language here at issue--contains an important limitation. It says that the amount of "interest deductible" shall be the amount by which "interest expense exceeds interest and dividend income . . . not subject to allocation by formula," i.e., the amount by which the interest expense exceeds the interest and dividends that the nondomiciliary corporation has received from nonunitary business or investment.[61] Suppose the Illinois tin can manufacturer has interest expense of $150,000; and suppose it receives $100,000 in dividend income from a nonunitary New Zealand sheep-farming subsidiary. California's rule authorizes an interest deduction, not of $150,000, but of $50,000, for the deduction is allowed only insofar as the interest expense "exceeds" this other unrelated income. . . .

     The question before us then is reasonably straightforward: Does the Constitution permit California to carve out an exception to its interest expense deduction, which it measures by the amount of nonunitary dividend and interest income that the nondomiciliary corporation has received? Petitioner, Hunt-Wesson, is successor in interest to a nondomiciliary corporation. That corporation incurred interest expense during the years at issue. California disallowed the deduction for that expense insofar as the corporation had received relevant nonunitary dividend and interest income. Hunt-Wesson challenged the constitutional validity of the disallowance. The California Court of Appeal found it constitutional,[62] and the California Supreme Court denied review.[63] We granted certiorari to consider the question.

II

     Relevant*[64] precedent makes clear that California's rule violates the Due Process and Commerce Clauses of the Federal Constitution. In Container,[65] this Court wrote that the "Due Process and Commerce Clauses ... do not allow a State to tax income arising out of interstate activities--even on a proportional basis--unless there is a ` "minimal connection" or "nexus" between the interstate activities and the taxing State, and "a rational relationship between the income attributed to the State and the intrastate values of the enterprise." ' " [66] The parties concede that the relevant income here--that which falls within the scope of the statutory phrase "not allocable by formula"--is income that, like the New Zealand sheep farm in our example, by itself bears no "rational relationship" or "nexus" to California. Under our precedent, this "nonunitary" income may not constitutionally be taxed by a State other than the corporation's domicile, unless there is some other connection between the taxing state and the income. [67]

     California's statute does not directly impose a tax on nonunitary income. Rather, it simply denies the taxpayer use of a portion of a deduction from unitary income (income like that from tin can manufacture in our example), income which does bear a "rational relationship" or "nexus" to California. But, as this Court once put the matter, a " `tax on sleeping measured by the number of pairs of shoes you have in your closet is a tax on shoes.' ".[68] California's rule measures the amount of additional unitary income that becomes subject to its taxation (through reducing the deduction) by precisely the amount of nonunitary income that the taxpayer has received. And for that reason, that which California calls a deduction limitation would seem, in fact, to amount to an impermissible tax.[69]

     However, this principle does not end the matter. California offers a justification for its rule that seeks to relate the deduction limit to collection of California's tax on unitary income. If California could show that its deduction limit actually reflected the portion of the expense properly related to nonunitary income, the limit would not, in fact, be a tax on nonunitary income. Rather, it would merely be a proper allocation of the deduction. [70]

     California points out that money is fungible, and that consequently it is often difficult to say whether a particular borrowing is "really" for the purpose of generating unitary income or for the purpose of generating nonunitary income. California's rule prevents a firm from claiming that it paid interest on borrowing for the first purpose (say, to build a tin can plant) when the borrowing is "really" for the second (say, to buy shares in the New Zealand sheep farm). Without some such rule, firms might borrow up to the hilt to support their (more highly taxed) unitary business needs, and use the freed unitary business resources to purchase (less highly taxed) nonunitary business assets. This "tax arbitrage" problem, California argues, is why this Court upheld the precursor of 26,[71] which denies the taxpayer an interest deduction insofar as the interest expense was "incurred or continued to purchase or carry" tax-exempt obligations or securities.[72] This Court has consistently upheld deduction denials that represent reasonable efforts properly to allocate a deduction between taxable and tax-exempt income, even though such denials mean that the taxpayer owes more than he would without the denial.[73]

     The California statute, however, pushes this concept past reasonable bounds. In effect, it assumes that a corporation that borrows any money at all has really borrowed that money to "purchase or carry,"[74] its nonunitary investments (as long as the corporation has such investments), even if the corporation has put no money at all into nonunitary business that year. Presumably California believes that, in such a case, the unitary borrowing supports the nonunitary business to the extent that the corporation has any nonunitary investment because the corporation might have, for example, sold the sheep farm and used the proceeds to help its tin can operation instead of borrowing.

     At the very least, this last assumption is unrealistic. And that lack of practical realism helps explain why California's rule goes too far. A state tax code that unrealistically assumes that every tin can borrowing first helps the sheep farm (or the contrary view that every sheep farm borrowing first helps the tin can business) simply because of the theoretical possibility of a hypothetical sale of either business is a code that fails to "actually reflect a reasonable sense of how income is generated,"[75] and in doing so assesses a tax upon constitutionally protected nonunitary income. That is so even if, as California claims, its rule attributes all interest expense both to unitary and to nonunitary income. And it is even more obviously so if, as Hunt-Wesson claims, California attributes all sheep-farm-related borrowing to the sheep farm while attributing all tin-can-related borrowing first to the sheep farm as well.

     No other taxing jurisdiction, whether federal or state, has taken so absolute an approach to the tax arbitrage problem that California presents. Federal law in comparable circumstances (allocating interest expense between domestic and foreign source income) uses a ratio of assets and gross income to allocate a corporation's total interest expense.[76] In a similar, but much more limited, set of circumstances, the federal rules use a kind of modified tracing approach--requiring that a certain amount of interest expense be allocated to foreign income in situations where a United States business group's loans to foreign subsidiaries and the group's total borrowing have increased relative to recent years (subject to a number of adjustments), and both loans and borrowing exceed certain amounts relative to total assets.[77] Some States other than California follow a tracing approach.[78] Some use a set of ratio-based formulas to allocate borrowing between the generation of unitary and nonunitary income.[79] And some use a combination of the two approaches.[80] No other jurisdiction uses a rule like California's.

     Ratio-based rules like the one used by the Federal Government and those used by many States recognize that borrowing, even if supposedly undertaken for the unitary business, may also (as California argues) support the generation of nonunitary income. However, unlike the California rule, ratio-based rules do not assume that all borrowing first supports nonunitary investment. Rather, they allocate each borrowing between the two types of income. Although they may not reflect every firm's specific actions in any given year, it is reasonable to expect that, over some period of time, the ratios used will reflect approximately the amount of borrowing that firms have actually devoted to generating each type of income. Conversely, it is simply not reasonable to expect that a rule that attributes all borrowing first to nonunitary investment will accurately reflect the amount of borrowing that has actually been devoted to generating each type of
income.

     Because California's offset provision is not a reasonable allocation of expense deductions to the income that the expense generates, it constitutes impermissible taxation of income outside its jurisdictional reach. The provision therefore violates the Due Process and Commerce Clauses of the Constitution.. . .

Appendix

Cal. Rev. & Tax Code §24344. Interest; restrictions

"(a) Except as limited by subsection (b), there shall be allowed as a deduction all interest paid or accrued during the income year on indebtedness of the taxpayer.

"(b) [T]he interest deductible shall be an amount equal to interest income subject to allocation by formula, plus the amount, if any, by which the balance of interest expense exceeds interest and dividend income (except dividends deductible under the provisions of Section 24402) not subject to allocation by formula. Interest expense not included in the preceding sentence shall be directly offset against interest and dividend income (except dividends deductible under the provisions of Section 24402) not subject to allocation by formula.

§24402. Dividends

"Dividends received during the income year declared from income which has been included in the measure of the taxes imposed under Chapter 2 or Chapter 3 of this part upon the taxpayer declaring the dividends."

---

[1] United States v. Bess , 357 U. S. 51, 56-57 (1958).

[2] See Ark. Code Ann. §28-9-214 (1987) (intestate interest passes "[f]irst, to the children of the intestate").

[3] Ark. Code Ann. §§28-2-101, 28-2-107 (1987).

[4] §28-2-108.

[5] Drye Family 1995 Trust v. United States , 152 F. 3d 892 (1998).

[6] Id., at 898.

#[7] In the view of those courts, state law holds sway. Under their approach, in a State adhering to an acceptance-rejection theory, under which a property interest vests only when the beneficiary accepts the inheritance or devise, the disclaiming taxpayer prevails and the federal liens do not attach. If, instead, the State holds to a transfer theory, under which the property is deemed to vest in the beneficiary immediately upon the death of the testator or intestate, the taxpayer loses and the federal lien runs with the property. See Leggett v. United States , 120 F. 3d 592, 594 (CA5 1997); Mapes v. United States , 15 F. 3d 138, 140 (CA9 1994); accord, United States v. Davidson , 55 F. Supp. 2d 1152, 1155 (Colo. 1999). Drye maintains that Arkansas adheres to the acceptance-rejection theory.

[8] 26 U. S. C. §6321.

#[9] The Code further provides:

"Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed (or a judgment against the taxpayer arising out of such liability) is satisfied or becomes unenforceable by reason of lapse of time." 26 U. S. C. §6322.

[10] United States v. National Bank of Commerce, 472 U. S. 713, 719-720 (1985) (citing 4 B. Bittker, Federal Taxation of Income, Estates and Gifts ¶ ;111.5.4, p. 111-100 (1981)); see also Glass City Bank v. United States , 326 U. S. 265, 267 (1945) ("Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes.").

[11] Jewett v. Commissioner , 455 U. S. 305, 309 (1982) (quoting S. Rep. No. 665, 72d Cong., 1st Sess., 39 (1932); H. R. Rep. No. 708, 72d Cong., 1st Sess., 27 (1932)).

[12] §§6334(a)(1), (2), (4), (7).

[13] See Bess , 357 U. S., at 57 ("The fact that ... Congress provided specific exemptions from distraint is evidence that Congress did not intend to recognize further exemptions which would prevent attachment of [federal tax] liens[.]");United States v. Mitchell, 403 U. S. 190, 205 (1971) ("Th[e] language [of §6334] is specific and it is clear and there is no room in it for automatic exemption of property that happens to be exempt from state levy under state law.").

#[14] See Pennell, Recent Wealth Transfer Tax Developments, in Sophisticated Estate Planning Techniques 69, 117-118 (ALI-ABA Continuing Legal Ed. 1997) ("The fact that a qualified disclaimer by an estate beneficiary is deemed to relate back to the decedent's death for state property law or federal gift tax purposes is not sufficient to preclude a federal tax lien for the disclaimant's delinquent taxes from attaching to the disclaimed property as of the moment of the decedent's death... . [T]he qualified disclaimer provision in §2518 only applies for purposes of Subtitle B and the lien provisions are in Subtitle F.").

[15] Leggett v. United States , 120 F. 3d 592, 597 (CA5 1997) ("Section 6321 adopts the state's definition of property interest."); and Mapes v. United States , 15 F. 3d 138, 140 (CA9 1994) ("For the answer to th[e] question [whether taxpayer had the requisite interest in property], we must look to state law, not federal law.").

#[16] See, e.g. , United States v. National Bank of Commerce , 472 U. S. 713, 722 (1985) ("[T]he federal statute `creates no property rights but merely attaches consequences, federally defined, to rights created under state law.' ") (quoting United States v. Bess , 357 U. S. 51, 55 (1958)).

[17] 472 U. S., at 727 .

[18] Cf. Morgan v. Commissioner , 309 U. S. 78, 80 (1940) ("State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed.").

[19] National Bank of Commerce, 472 U. S., at 723 -727.

[20] Bess , 357 U. S., at 56 -57.

#[21] Accord, Bank One Ohio Trust Co. v. United States , 80 F. 3d 173, 176 (CA6 1996) ("Federal law did not create [the taxpayer's] equitable income interest [in a spendthrift trust], but federal law must be applied in determining whether the interest constitutes `property' for purposes of § 6321."); 21 West Lancaster Corp. v. Main Line Restaurant, Inc. , 790 F. 2d 354, 357-358 (CA3 1986) (although a liquor license did not constitute "property" and could not be reached by creditors under state law, it was nevertheless "property" subject to federal tax lien); W. Plumb, Federal Tax Liens 27 (3d ed. 1972) ("[I]t is not material that the economic benefit to which the [taxpayer's local law property] right pertains is not characterized as `property' by local law.").

[22] Id. , at 55-56 ("It would be anomalous to view as `property' subject to lien proceeds never within the insured's reach to enjoy.").

#[23] Compatibly, in Aquilino v. United States , 363 U. S. 509 (1960), we held that courts should look first to state law to determine " `the nature of the legal interest' " a taxpayer has in the property the Government seeks to reach under its tax lien. Id. , at 513 (quoting Morgan v. Commissioner , 309 U. S. 78, 82 (1940)). We then reaffirmed that federal law determines whether the taxpayer's interests are sufficient to constitute "property" or "rights to property" subject to the Government's lien. Id. , at 513-514. We remanded in Aquilino for a determination whether the contractor-taxpayer held any beneficial interest, as opposed to "bare legal title," in the funds at issue. Id., at 515-516; see also Note, Property Subject to the Federal Tax Lien, 77 Harv. L. Rev. 1485, 1491 (1964) (" Aquilino supports the view that the Court has chosen to apply a federal test of classification, for the contractor concededly had legal title to the funds and yet in remanding the Court indicated that this state-created incident of ownership was not a sufficient `right to property' in the contract proceeds to allow the tax lien to attach. In this sense Aquilino follows Bess in requiring that the taxpayer must have a beneficial interest in any property subject to the lien." (footnote omitted)).

[24] Mitchell , 403 U. S., at 204

[25] United States v. Irvine, 511 U. S. 224, 240 (1994).

[26] See 152 F. 3d, at 895 (although Code does not define "property" or "rights to property," appellate courts read those terms to encompass "state-law rights or interests that have pecuniary value and are transferable").

[27] See id. , at 895-896 (citing several Arkansas Supreme Court decisions, including: Clark v. Rutherford , 227 Ark. 270, 270-271, 298 S. W. 2d 327, 330 (1957); Bradley Lumber Co. of Ark. v. Burbridge , 213 Ark. 165, 172, 210 S. W. 2d 284, 288 (1948); Leggett v. Martin , 203 Ark. 88, 94, 156 S. W. 2d 71, 74-75 (1941)).

#[28] In recognizing that state-law rights that have pecuniary value and are transferable fall within §6321, we do not mean to suggest that transferability is essential to the existence of "property" or "rights to property" under that section. For example, although we do not here decide the matter, we note that an interest in a spendthrift trust has been held to constitute " `property' for purposes of § 6321" even though the beneficiary may not transfer that interest to third parties. See Bank One , 80 F. 3d, at 176. Nor do we mean to suggest that an expectancy that has pecuniary value and is transferable under state law would fall within §6321 prior to the time it ripens into a present estate.

[29] see Ark. Code Ann. §28-2-101 (1987)

[30] See Brief for Petitioners 13 (right to disclaim is not transferable and has no pecuniary value).

[31] See Hirsch, The Problem of the Insolvent Heir, 74 Cornell L. Rev. 587, 607-608 (1989).

[32] Morgan , 309 U. S., at 83 .

[33] See National Bank of Commerce , 472 U. S., at 725 (confirming that unqualified "right to receive property is itself a property right" subject to the tax collector's levy)

[34] 26 U. S. C. §6511(b)(2)(A).

[35] see §3402

[36] §6511(a); see §6511(b)(1).

[37] Ibid. ; see generally Commissioner v. Lundy, 516 U. S. 235, 240 (1996) (explaining that §6511 contains two separate timeliness provisions: (1) §6511(b)(1)'s filing deadline and (2) §6511(b)(2)'s ceilings, which are defined by reference to that provision's "look-back period[s]").

[38] App. to Pet. for Cert. A-1, judgt. order reported at 172 F. 3d 918 (CADC 1999).

[39] Accord, e.g., Dantzler v. United States, 183 F. 3d 1247, 1250-1251 (CA11 1999) (estimated income tax); Ertman v. United States, 165 F. 3d 204, 207 (CA2 1999) (same); Ehle v. United States , 720 F. 2d 1096, 1096-1097 (CA9 1983) (withholding from wages).

[40] Ford v. United States, 618 F. 2d 357, 360-361, and n. 4 (1980) (suggesting that a remittance respecting any sort of tax is "paid" under §6511 only when the Service assesses the tax liability)

[41] 527 U. S. 1067 (1999)

[42] See Brief for Petitioner 9 ("Payment of the income tax ... occurred at the earliest on June 1, 1993, when the amount of that tax first became known, and more precisely on July 19, 1993, when the income tax was assessed").

[43] see 26 CFR §301.6315-1 (1999) ("The aggregate amount of the payments of estimated tax should be entered upon the income tax return for such taxable year as payments to be applied against the tax shown on such return"); §301.6402-3(a)(1) (providing that "in the case of an overpayment of income taxes, a claim for credit or refund of such overpayment shall be made on the appropriate income tax return")

[44] 26 CFR §301.6315-1 (1999) (emphasis added).

[45] see supra, at 4

[46] See §6151(a) ("[T]he person required to make [a return of tax] shall, without assessment or notice and demand from the Secretary, pay such tax ... at the time and place fixed for filing the return" (emphasis added)); §6213(b)(4) ("Any amount paid as a tax or in respect of a tax may be assessed upon the receipt of such payment " (emphasis added)).

[47] Rosenman v. United States, 323 U. S. 658 (1945)

[48] Id., at 661.

[49] See ibid. (noting that "no extraneous relevant aids to construction have been called to our attention").

[50] id., at 663.

#[51]  Central to our analysis in this regard was a concern that the Service should not be able to treat the same remittance as a payment for statute of limitations purposes--disadvantaging the taxpayer by decreasing the time in which a refund claim could be filed--and as a deposit for purposes of accrual of interest on overpayments--disadvantaging the taxpayer by starting the accrual of interest only at assessment. Rosenman, 323 U. S., at 662 -663. Indeed, we suggested that an amendment to the Code disapproving of the Service's treatment of remittances as deposits for interest purposes might change the analysis. Id., at 663 (citing Current Tax Payment Act of 1943, §4(d), 57 Stat. 140) (presently codified at 26 U. S. C. §6401(c)).

[52] see 26 U. S. C. §6501(a) (1994 ed., Supp. III).

[53] (1994 ed. and Supp. III)

[54] supra, at 5

#[55] We need not address the proper treatment under §6511 of remittances that, unlike withholding and estimated income tax, are not governed by a "deemed paid" provision akin to §6513(b). Such remittances might include remittances of estimated estate tax, as in Rosenman , or remittances of any sort of tax by a taxpayer under audit in order to stop the running of interest and penalties, see , e.g., Moran v. United States , 63 F. 3d 663 (CA7 1995). In the latter situation, the taxpayer will often desire treatment of the remittance as a deposit--even if this means forfeiting the right to interest on an overpayment--in order to preserve jurisdiction in the Tax Court, which depends on the existence of a deficiency, 26 U. S. C. §6213 (1994 ed. and Supp. III), a deficiency that would be wiped out by treatment of the remittance as a payment. We note that the Service has promulgated procedures to govern classification of a remittance as a deposit or payment in this context. See Rev. Proc. 84-58, 1984-2 Cum. Bull. 501.

[56] Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U. S. 768, 772 (1992).

[57] Id. , at 773 (quoting Exxon Corp. v. Department of Revenue of Wis., 447 U. S. 207, 224 (1980), in turn quoting Mobil Oil Corp. v. Commissioner of Taxes of Vt., 445 U. S. 425, 442 , 439 (1980))

[58] Cal. Rev. & Tax Code Ann. §§25128, 25129, 25132, 25134 (West 1979).

[59] Allied-Signal , 504 U. S., at 773 (internal quotation marks omitted)

[60] Ibid

[61] Cal. Rev. & Tax Code Ann. §24344 (West 1979) (emphasis added); Appendix, infra .

[62] No. A079969 (Dec. 11, 1998), App. 54; see also Pacific Tel. & Tel. Co. v. Franchise Tax Bd. , 7 Cal. 3d 544, 498 P. 2d 1030 (1972) (upholding statute)

[63] App. 67

[64] *Does the court use the phrase “relevant precedent” to distinguish it from “irrelevant precedent” or “relevant but not precedent?” Certainly the word “relevant” couldn’t be redundant or irrelevant, or could it?

[65] Container Corp. of America v. Franchise Tax Bd. , 463 U. S. 159 (1983)

[66] Id., at 165-166 (quoting Exxon Corp. , 447 U. S., at 219 -220, in turn quoting Mobil Oil Corp., 445 U. S., at 436 , 437). Cf. International Harvester Co. v. Department of Treasury, 322 U. S. 340, 353 (1944) (Rutledge, J., concurring in part and dissenting in part) ("If there is a want of due process to sustain" a tax, "by that fact alone any burden the tax imposes on the commerce among the states becomes `undue' ").

[67] Allied-Signal , 504 U. S., at 772 -773.

[68] Trinova Corp. v. Michigan Dept. of Treasury, 498 U. S. 358, 374 (1991) (quoting Jenkins, State Taxation of Interstate Commerce, 27 Tenn. L. Rev. 239, 242 (1960))

[69] National Life Ins. Co. v. United States, 277 U. S. 508 (1928) (finding that a federal statute that reduced an insurance company's tax deduction for reserves by the amount of tax-exempt interest the company received from a holding of "tax-free" municipal bonds constituted unlawful taxation of tax-exempt income).

[70] See Denman v. Slayton, 282 U. S. 514 (1931) (upholding federal tax code's denial of interest expense deduction where borrowing is incurred to "purchase or carry" tax-exempt obligations).

[71] U. S. C. §265(a)(2)

[72] Denman v. Slayton, supra , at 519

[73] E.g. , First Nat. Bank of Atlanta v. Bartow County Bd. of Tax Assessors, 470 U. S. 583 (1985).

[74] cf. 26 U. S. C. §265(a)(2)

[75] Container Corp. , 463 U. S., at 169

[76] See 26 CFR §§1.861-9T(f), (g) (1999).

[77] See §1.861-10.

[78] See, e.g., D. C. Mun. Regs., tit. 9, §123.4 (1998); Ga. Rules and Regs. §560-7- 7.03(3) (1999).

[79] See, e.g., Ala. Code §40-18-35(a)(2) (1998); La. Reg. §1130(B)(1) (1988).

[80] See, e.g., N. M. Admin. Code, Tit. 3, §5.5.8 (1999); Utah Code Ann. §59-7-101 (19) (1999).