Did Texas unconstitutionally discriminate against the federal government by taxing materials used by federal construction contractors?

Texas AG Opinion JM-207: Federal Contractor Sales Tax

Plain-English summary

The comptroller asked whether an amendment to Tax Code section 151.311 unconstitutionally discriminated against the United States and whether it improperly distinguished federal contractors using lump-sum contracts from those using separated contracts. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Before the amendment, contractors could claim an exemption for tangible personal property used to improve realty belonging to federal, state, local, religious, educational, and public-service entities that were themselves exempt. The amendment removed the federal government and its instrumentalities from the contractor exemption while retaining specified state, local, and nonprofit categories. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

JM-207 concluded that the change did not impose a tax directly on the federal government. It taxed tangible personal property used by a contractor and removed what the opinion described as the federal government's previously favored treatment. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Relying heavily on Washington v. United States, the opinion compared the combined economic burden on federal contractors and the federal purchaser with the burden on private construction transactions. It concluded that section 151.311 did not treat the federal government or those dealing with it worse than similarly situated private parties. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

JM-207 also concluded that the differing legal incidence associated with lump-sum and separated contracts did not create unconstitutional discrimination. Under the analysis it adopted, the question was the resulting economic burden rather than which party formally remitted the tax. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Currency note

This opinion was issued in 1984. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

Did the amendment tax the federal government directly?

No. JM-207 said the tax applied to tangible personal property used by a contractor to improve real property, rather than directly to the federal political entity. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Why was removing the federal exemption not discriminatory?

The opinion said the amendment placed federal construction transactions in the same economic position as similarly situated private construction transactions. It treated removal of favored status as different from singling out the federal government for a new burden. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

What was the difference between lump-sum and separated contracts?

The quoted comptroller rule defined a separated contract as stating distinct prices for materials and labor. A lump-sum contract stated one combined price without separating the material charge from skill and labor. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Did that contract-form difference change the constitutional result?

No. JM-207 concluded that section 151.311 did not impermissibly discriminate between federal realty contractors using the two contract forms. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Background and statutory framework

Section 151.311 exempted contractor-purchased tangible personal property used to improve realty for specified exempt organizations. The 1983 special-session amendment limited the governmental portion of that contractor exemption to entities listed in sections 151.309(4) and (5), meaning Texas and its political subdivisions rather than the federal entities in subdivisions (1) through (3). Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

JM-207 reviewed the doctrine that a state could not tax the United States directly and that even an indirect tax could fail if it discriminated against the federal government or substantially interfered with federal activities. It also noted the modern narrowing of implied federal tax immunity. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

The opinion contrasted Phillips Chemical, where federal-property lessees bore a greater burden than comparable state-property lessees, with Washington, where federal construction transactions bore no greater combined economic burden than private ones. JM-207 treated the Texas amendment as analogous to the latter. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Citations and references

• Tax Code sections 151.309, 151.310, and 151.311 supplied the exempt-entity and contractor-property provisions discussed in JM-207. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf
• United States v. New Mexico, 455 U.S. 720 (1982), supplied the modern rule limiting implied constitutional tax immunity to the United States itself or a closely connected agency or instrumentality. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf
• Washington v. United States, 460 U.S. 536 (1983), supplied the economic-burden comparison that controlled JM-207's discrimination analysis. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf
• Phillips Chemical Company v. Dumas Independent School District, 361 U.S. 376 (1960), supplied the contrasting example of a tax scheme that treated federal-property users worse than comparable users of state property. Source: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Source

• Landing page: https://www.texasattorneygeneral.gov/opinions/jim-mattox/jm-0207
• Original PDF: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1984/jm0207.pdf

Original opinion text

Best-effort transcription from a scanned PDF. Minor errors may remain. The linked PDF is authoritative.

The Attorney General of Texas

October 4, 1984

Honorable Bob Bullock
Comptroller of Public Accounts
L.B.J. State Office Building
Austin, Texas 78774

Opinion No. JM-207

Re: Whether section 151.311 of the Tax Code unconstitutionally discriminates against the federal government

Dear Mr. Bullock:

Chapter 151 of the Tax Code imposes limited sales, excise and use taxes on businesses which operate within this state and engage in certain specified activities. Subchapter H of chapter 151 sets forth specific exemptions to the imposition of such a tax. One such exemption, set forth in section 151.311, removes from the ambit of the tax tangible personal property purchased by a contractor and used for the improvement of realty belonging to entities which themselves are exempt from the imposition of the tax. Legislation enacted during the recent special session amended section 151.311 to remove the United States, its agencies, and its instrumentalities from the list of organizations receiving the section 151.311 exemption. Accordingly, you ask us the following two questions:

I hereby request your opinion on whether the recent amendment to section 151.311, V.T.C.S., the Tax Code, discriminates unconstitutionally against the United States, its agencies and instrumentalities. If you conclude that it does not, I hereby request your further opinion on whether the amendment unconstitutionally discriminates between contractors who improve realty for the federal government under lump sum contracts and those who do so under separated contracts.

We answer both your questions in the negative. Section 151.311, as amended, does not impermissibly discriminate against either the United States, its agencies, and its instrumentalities or between contractors who improve realty for the federal government under "lump sum" contracts and those who do so under "separated" contracts.

Section 151.311 of the Tax Code now provides the following:

Sec. 151.311. PROPERTY USED FOR IMPROVEMENT OF REALTY OF AN EXEMPT ORGANIZATION. Tangible personal property purchased by a contractor for use in the performance of a contract for the improvement of realty for an organization exempted from the taxes imposed by this chapter by Section 151.309(4) or (5) or Section 151.310 of this code is exempted from the taxes imposed by this chapter to the extent of the value of the tangible personal property used or consumed or both in the performance of the contract.

Acts 1983, 68th Leg., 2nd C.S., ch. 31, art. XII, § 1, at 551. The second portion of the language was added by the amendment. Section 151.309 of the Tax Code sets forth the following:

§ 151.309. Governmental Entities. A taxable item sold, leased, or rented to, or stored, used, or consumed by, any of the following governmental entities is exempted from the taxes imposed by this chapter:

(1) the United States;

(2) an unincorporated instrumentality of the United States;

(3) a corporation that is an agency or instrumentality of the United States and is wholly owned by the United States or by another corporation wholly owned by the United States;

(4) this state; or

(5) a county, city, special district, or other political subdivision of this state.

Section 151.310 of the Tax Code acts to exempt religious, educational, and public service organizations as defined therein.

Prior to its amendment, section 151.311 exempted from the imposition of the tax tangible personal property used by a contractor for the improvement of realty belonging to all organizations listed as exempt in section 151.309. With the amendment to section 151.311, the only contractors of governmental entities so exempted are those which contract with the state and all its political subdivisions. Contractors of the United States, its agencies, and its instrumentalities are no longer exempted.

Your first concern is that the statute as amended impermissibly discriminates against the federal government and its instrumentalities and thereby violates the United States Constitution. Section 151.311 does not affect the traditional immunity from taxation afforded political entities and impose a tax directly on political entities; all that is involved is the tax on tangible personal property used by a contractor to improve real property. The federal government is not being singled out for the imposition of the tax; it is simply being treated in the same way that entities in the private sector similarly situated are treated. The amendment then does not impose a new tax on the federal government. It serves merely to remove the federal government from its heretofore favored status. The significance of these two aspects of the tax will be readily apparent when two recent United States Supreme Court decisions are analyzed.

It has long been held that a state may not impose a tax directly upon the United States or any of its instrumentalities. Mayo v. United States, 319 U.S. 441 (1943). Such immunity from taxation is grounded in the Supremacy Clause of the United States Constitution, article VI, clause 2. McCulloch v. Maryland, 4 Wheat. 316 (1819). No such direct tax is imposed here.

A corollary to this principle is that

a tax may be invalid even though it does not fall directly on the United States if it operates so as to discriminate against the Government or those with whom it deals.

United States v. City of Detroit, 355 U.S. 466, 473 (1958); see also Memphis Bank & Trust Co. v. Garner, 459 U.S. 392 (1983). A tax is not invalid on the basis of prohibited discrimination simply because its imposition has an effect upon the United States or because the federal government shoulders the entire burden of the economic levy. Alabama v. King & Boozer, 314 U.S. 1 (1941). Specifically,

state taxes on contractors [performing work for the federal government] are constitutionally invalid if they discriminate against the Federal Government, or substantially interfere with its activities.

United States v. New Mexico, 455 U.S. 720, 735 n.11 (1982). Moreover,

the economic burden on a federal function of a state tax imposed on those who deal with the Federal Government does not render the tax unconstitutional so long as the tax is imposed equally on the other similarly situated constituents of the State.

United States v. County of Fresno, 429 U.S. 452, 462 (1977). At issue, then, is whether the federal government or those with whom it does business have been singled out for imposition of the tax. We conclude that they have not.

The proper test to be invoked in order to determine discrimination has not always been clear, nor have the cases been consistent. The Supreme Court itself has indicated that cases in this field have "been marked from the beginning by inconsistent decisions and excessively delicate distinctions." United States v. New Mexico, supra, at 730. For example, one line of cases set forth an "economic burden" test, under which the validity of the tax turned upon whether a tax imposed on a contractor was a substantial burden upon the government. See, e.g., Helvering v. Mountain Producers Corporation, 303 U.S. 376 (1938); James v. Dravo Contracting Company, 302 U.S. 134 (1937). Other cases imposed a "legal incidence" test, which determined whether the interest taxed is that of the federal government or that of the contractor. See, e.g., United States v. County of Allegheny, 322 U.S. 174 (1944); Trinityfarm Construction Company v. Grosjean, 291 U.S. 466 (1934). Regardless of the test imposed, it is clear that "in recent years the Supreme Court has curtailed sharply the doctrine of implied delegated immunity." United States v. County of Allegheny, supra, at 177. See United States v. City of Detroit, 355 U.S. 466 (1958); Oklahoma Tax Commission v. Texas Company, 336 U.S. 342 (1949). Two recent Supreme Court cases, however, have removed much of the confusion and enunciated a clear test.

In Washington v. United States, 460 U.S. 536 (1983), the court upheld the scheme of sales taxes imposed by the state of Washington which operated in a way seemingly more disparate in its treatment of federal contractors than that proposed for imposition in Texas. In support of its argument, the United States relied principally upon Phillips Chemical Company v. Dumas Independent School District, 361 U.S. 376 (1960).

Such a method of analysis is instructive in considering the effect of the amendment to section 151.311. Prior to the recent amendment, all contractors paid sales taxes on tangible personal property, except that purchased for use in improving the real property of organizations which were themselves exempt. The three kinds of organizations which were exempt were: (1) the state and its political subdivisions; (2) the federal government and its instrumentalities; and (3) religious, educational, and public service organizations as defined by the code.

Unlike the tax scheme attacked in Phillips, which effectively singled out for adverse economic treatment those engaged in business with the federal government, the recent amendment to section 151.311 simply removed the federal government and its instrumentalities from the list of exempt organizations for the limited purpose of imposing a tax already imposed on contractors engaged in business in the private sector. The amendment to section 151.311, like the Washington tax scheme, simply removes the federal government and those with whom it deals from favored status and treats them like similarly situated entities in the private sector.

In Washington, the Court compared the federal government and its contractors with the private sector and its contractors and concluded that if the burdens imposed on each, direct as well as indirect, are equal, no problem of impermissible discrimination will arise. The opinion stated that "the opportunity for the parties to allocate the economic burden of the tax among themselves [is] sufficient. No more should be required here." 460 U.S. at 544.

The amendment to section 151.311 imposes exactly the same burden, direct as well as indirect, on the federal government and its contractors that it places on private businesses and their contractors. Accordingly, we conclude that the amendment does not impermissibly discriminate against either the federal government or those with whom it deals, in violation of the Supremacy Clause of the United States Constitution.

Your second question asks whether the amendment unconstitutionally discriminates between contractors who improve realty for the federal government under "lump sum" contracts and those who do so under "separated" contracts. "Separated contract" is defined in your regulations as follows:

(5) Separated contract -- A contract in which the agreed contract price is divided into a separately stated agreed contract price for materials and a separately stated agreed contract price for skill and labor. If prices of materials and labor are separately stated, the fact that the charges are added together and a sum total given is irrelevant. Cost-plus contracts are generally regarded as separated contracts.

34 Tex. Adm. Code § 3.291(a)(5). "Lump-sum contract" is defined as:

(4) Lump-sum contract -- A contract in which the agreed contract price is one lump-sum amount and in which the charges for materials are not separate from the charges for skill and labor. Separated invoices issued to the customer will not change a lump-sum contract into a separated contract unless the invoices are incorporated into the contract and specifically amend the original contract.

Comptroller of Public Accounts, 8 Tex. Reg. 1585 (1983), adopted, 8 Tex. Reg. 2280 (1983) (amending 34 Tex. Adm. Code § 3.291(a)(4)).

The court in Washington has made clear that any distinction between these two types of contract is a distinction without a difference. The important consideration is not whether the State differentiates in determining what entity shall bear the legal incidence of the tax, but whether the tax is discriminatory with regard to the economic burdens that result. The State does not discriminate against the Federal Government and those with whom it deals unless it treats someone else better than it treats them. 460 U.S. at 544-45.

We conclude that section 151.311 does not impermissibly discriminate between contractors who improve realty for the federal government under "lump sum" contracts and those who do so under "separated" contracts.

SUMMARY

Section 151.311 of the Tax Code, as amended, does not impermissibly discriminate against either the United States, its agencies, and its instrumentalities or between contractors who improve realty for the federal government under "lump sum" contracts and those who do so under "separated" contracts.

Very truly yours,

JIM MATTOX
Attorney General of Texas

TOM GREEN
First Assistant Attorney General

DAVID R. RICHARDS
Executive Assistant Attorney General

Prepared by Jim Moellinger
Assistant Attorney General

APPROVED:
OPINION COMMITTEE

Rick Gilpin, Chairman
Colin Carl
Susan Garrison
Tony Guillory
Jim Moellinger
Nancy Sutton