Class Action Against Illinois Section 529 Programs Alleges That Tax Parity Is Constitutionally Required

Litigation over the constitutionality of state tax benefits restricted to a state's own financing programs has spread to Section 529 college savings programs from the municipal bond sector, which has generated a case that currently awaits a U.S. Supreme Court decision.

On May 15, 2007, Maryam Ahmad, individually and on behalf of a class of Illinois taxpayers who invest in out-of-state Section 529 programs, brought suit in the Circuit Court of Cook County, Illinois. The complaint challenges the constitutionality of provisions of the Illinois Income Tax Act that provide a deduction from adjusted gross income of up to $10,000 for investments in the ìCollege Illinois!î prepaid tuition program and the ìBright Startî and ìBright Directionsî college savings programs, but that do not offer a similar deduction for investments in Section 529 programs sponsored by other states. The lawsuit asserts that the Illinois tax statute facially discriminates against interstate commerce in violation of the so-called ìdormantî Commerce Clause of the United States Constitution. The lawsuit also alleges a violation of a provision of the Illinois constitution that requires reasonable classifications of the objects of taxation.

According to the complaint, the lead plaintiff in the Ahmad lawsuit pays taxes in Illinois but invests in Indiana's Section 529 program because the fees are lower than those of the Illinois programs. The complaint indicates that there are ìseveral hundred, and probably several thousand,î similarly situated class members and seeks:

class certification,

a declaratory judgment that the Illinois tax deduction for in-state Section 529 programs violates the federal and Illinois constitutions,

a declaratory judgment that the members of the class are entitled to tax refunds in the amount of the Illinois income taxes they would have saved if the deduction were available for out-of-state Section 529 programs,

an order obligating Illinois to create a common fund in an amount equal to the tax refunds claimed plus interest, and

attorneys' fees.

The Ahmad class action was filed a week before the U.S. Supreme Court decided to review a Kentucky case, Davis v. Kentucky, in which a Kentucky appellate court held that Kentucky's practice of exempting from state income taxation interest on municipal bonds issued in Kentucky while taxing interest on municipal bonds issued in other states violates the dormant Commerce Clause of the United States Constitution. The...