The U.S. Court of Appeals for the Fourth Circuit recently affirmed lower court rulings that the general tax exemptions applicable to Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), although not applicable to real property taxes, did cover real property transfer taxes in Maryland and South Carolina, thus making a distinction between property taxes and transfer taxes. 12 U.S.C. §§ 1723a(c)(2) and 1452(e).
The Fourth Circuit also upheld the South Carolina and Maryland district courts’ rulings that Congress, in providing the tax exemptions to Fannie Mae and Freddie Mac, acted within its Commerce Clause power. In exempting Fannie Mae and Freddie Mac from such taxes, the Fourth Circuit held that Congress could rationally have believed that state taxation would substantially interfere with or obstruct the legitimate purposes of Fannie Mae and Freddie Mac of regulating and stabilizing the secondary mortgage market.
A copy of the opinion is available at: http://www.ca4.uscourts.gov/Opinions/Published/131691.P.pdf.
In the course of their business, Fannie Mae and Freddie Mac acquired real property in both Maryland and South Carolina through foreclosures on mortgages that they owned or guaranteed.
When selling these properties to third persons, they refused to pay the transfer taxes and recording fees, claiming to be exempt under 12 U.S.C. §§ 1723a(c)(2) and 1452(e), respectively.
Maryland and South Carolina impose taxes on the ownership of real property, as well as excise taxes on the transfer of real property. Maryland’s property tax is imposed annually on owners of real property located in the State, based on the assessed value of the property. See Md. Code Ann., Tax-Prop. §§ 5-102(a), 6-101(a), 6-201(a). In addition, Maryland imposes a recordation tax on “instrument[s] of writing” (e.g., deeds, leases, and mortgages) that are recorded with the clerk of a circuit court, as well as a transfer tax on the same “instrument[s] of writing.” See id. §§ 12-102, 13-202. The amount of the recordation and transfer taxes are based on the “consideration” paid for the real property or the principal amount of debt secured. See id. §§ 12-103, 13-203. Maryland also authorizes counties to impose transfer taxes.
South Carolina similarly imposes an annual tax on the ownership of real property located in the State, based on its assessed valuation. See S.C. Code Ann. §§ 12-37-30, 12-37-210, 12-37-610. In addition, South Carolina imposes “recording fees” “for the privilege of recording deeds in which land . . . is transferred to another person.” Id. § 12-24-10(A).
As you may recall, Congress has exempted Fannie Mae and Freddie Mac generally from state and local taxes, “except that any real property of [either Fannie Mae or Freddie Mac] shall be subject to State, territorial, county, municipal, or local taxation to the same extent as other real property is taxed.” 12 U.S.C. § 1723a(c)(2) (as to Fannie Mae); see also id. § 1452(e) (as to Freddie Mac); id. § 4617(j)(2) (as to the FHFA).
The Maryland and South Carolina counties (collectively, the “Counties”) that collect these taxes disputed Fannie Mae’s and Freddie Mac’s claimed exemptions, contending that the exemptions did not cover state and local transfer taxes, including recording fees, insofar as they related to real property. The Counties commenced these actions (one in Maryland and two in South Carolina) for a declaratory judgment that Fannie Mae and Freddie Mac are liable for transfer taxes and recording fees and to recover as damages the taxes and fees that they refused to pay. The FHFA, as conservator of Fannie Mae and Freddie Mac, was also named a defendant in the Maryland case and intervened as a defendant in the South Carolina cases.
The South Carolina district court consolidated the two actions pending there and certified the consolidated action as a class action. The district court rejected the counties’ claims on the merits, concluding that the exclusion from the general tax exemptions covered only real property taxes and not transfer taxes. The court also rejected the South Carolina counties’ claim that the tax exemptions were unconstitutional. The Maryland district court did not reach the class action certification question but dismissed the Maryland county’s claims as a matter of law, again concluding that the exclusion from the general tax exemptions did not apply and that the exemptions themselves were a constitutional exercise of Congress’s Commerce Clause power.
The Counties appealed to the Fourth Circuit.
In conducting its analysis, the Fourth Circuit began by examining tax exemptions that applied to Fannie Mae and Freddie Mac. The general tax exemptions for Fannie Mae and Freddie Mac do not apply – and explicitly exclude -- state and local taxes on their “real property” “to the same extent as other real property is taxed.” 12 U.S.C. §1723a(c)(2); id. § 1452(e).
The Counties argued that “real property,” as used in the statutes, includes deeds to the property recorded by Fannie Mae and Freddie Mac because “deeds are ‘indispensable’ to ownership of real property; they are the principal evidence of ownership and true title.” The Counties reason that such a construction follows from the concept that real property ownership is a “bundle of sticks” that includes the right to transfer title. Consequently, by their account, a real property transfer tax is a tax on real property, which is excluded from the general tax exemptions provided for Fannie Mae and Freddie Mac.
Thus, according to the Counties, when a statute refers to a real property tax, it is also referring to transfer taxes. The Fourth Circuit did not agree. It stated that such a blur of the two taxes would mean analogously that any reference to a personal property tax (a tax on the ownership of personal property) must also be a reference to sales taxes imposed on the transfer of personal property.
The Fourth Circuit looked to Supreme Court precedent, noting that the Supreme Court made this very point clear when it stated that a property tax is “levied upon the property itself,” whereas a transfer tax is levied upon the “transfer of property.” United States v. Wells Fargo Bank, 485 U.S. 351, 355 (1988). As the Supreme Court explained, “an exemption of property from all taxation ha[s] an understood meeting: the property [is] exempt from direct taxation, but certain privileges of ownership, such as the right to transfer the property, [can] be taxed. Underlying this doctrine is the distinction between an excise tax, which is levied upon the use or transfer of property even though it might be measured by the property’s value, and a tax levied upon the property itself.” Id. at 355.
When that distinction is recognized, according to the Fourth Circuit, it becomes apparent that the exclusions allowing for the taxation of real property as “other real property is taxed,” refers to real property taxes imposed on the ownership of real property and not to transfer taxes imposed on the transfer of real property.
The Fourth Circuit noted that the Supreme Court applied the same distinction in Pittman v. Home Owners’ Loan Corp., 308 U.S. 21 (1939). In Pittman, the Court considered whether Maryland could impose a mortgage recordation tax on the Home Owners’ Loan Corporation. That corporation was subject to a statutory tax exemption with a real property exclusion materially identical to the ones in the present case. See id. at 31 n.3. The Court found that the corporation was exempt from the recordation tax, which necessarily meant that the real property exclusion did not apply to the recordation tax. Id. at 33. The Fourth Circuit found that the transfer taxes in the present case were analogous to the recordation tax in Pittman, and both are distinct from property taxes.
Moreover, the Fourth Circuit also recognized that the South Carolina and Maryland statutory schemes themselves confirm the divide between excise taxes and property taxes. Both States, in addition to imposing a tax on the transfer of real property, impose a separate direct tax on real property, using the same “subject to” language used in the federal exemption statutes.
In sum, the Fourth Circuit held that the real property exclusions from the general tax exemptions of 12 U.S.C. §§ 1723a(c)(2) and 1452(e) do not include transfer and recordation taxes.
Next, the Fourth Circuit addressed the Counties’ contention that Congress acted impermissibly in providing Fannie Mae and Freddie Mac with exemptions from state and local transfer taxes. Disputing the district courts’ conclusion that the exemptions were justified under the Commerce Clause, the Counties asserted that the transfer taxes were “assessed on local, intrastate activity -- the buying and selling of parcels of real estate,” and therefore any efforts to regulate them were not justified by the Commerce Clause but instead amounted to nothing less than an infringement on the States’ sovereign power to tax -- a power “indispensable to their existence” as Counties.
Initially, the Fourth Circuit addressed the Counties’ contention that it should review Congress’s authority to exempt Fannie Mae and Freddie Mac from state and local taxes under the strict-scrutiny standard of review. They argued that the “rights of the states to . . .impose taxes are just as fundamental, from a Constitutional standpoint, as the rights of individuals to Due Process and Equal Protection under the Fifth and Fourteenth Amendments.”
The Counties provided no authority for this position. The Fourth Circuit further noted that it is not required to formulate a new standard, as it is established that for a federal statute to pass constitutional muster under the Commerce Clause, there need only exist a “‘rational basis’ . . . for . . . concluding” that the regulated activities “taken in the aggregate, substantially affect interstate commerce.” Gonzales v. Raich, 545 U.S. 1, 22 (2005); see also Hodel v. Va. Surface Mining & Reclamation Ass’n, 452 U.S. 264, 276 (1981).
The Fourth Circuit noted the Supreme Court has often recognized Congress’s power to exempt entities from state taxation, but it has never indicated that such an exercise of power would be subject to strict scrutiny. See, e.g., Ariz. Dep’t of Revenue v. Blaze Constr. Co., 526 U.S. 32, 38 (1999);United States v. New Mexico, 455 U.S. 720, 737 (1988); United States v. City of Detroit, 355 U.S. 466, 474 (1958).
In the absence of a particular constitutional right that would trigger heightened scrutiny, the Fourth Circuit held that a congressional exemption from state taxation under the Commerce Clause is subject to rational-basis review.
The Fourth Circuit next addressed the merits of the Counties’ contention that the Commerce Clause does not authorize Congress to regulate local, intrastate activity, such as collecting taxes on “the buying and selling of parcels of real estate,” and therefore, the district courts erred in holding that Congress could reasonably conclude that state and local taxation would interfere with the stated missions of Fannie Mae and Freddie Mac.
In examining Congress’s authority, the Fourth Circuit noted that Congress has the power to “‘make all Laws which shall be necessary and proper’ to ‘regulate Commerce . . . among the several States.’” Raich, 545 U.S. at 22 (omission in original) (quoting U.S. Const., Art. I, § 8). As you may recall, the Supreme Court has identified three forms of regulation that are authorized by the Commerce Clause: (1) “Congress can regulate the channels of interstate commerce”; (2) “Congress has authority to regulate and protect the instrumentalities of interstate commerce”; and (3) “Congress has the power to regulate activities that substantially affect interstate commerce.” Id. at 16-17. Moreover, “when Congress enacts a general statutory framework regulating economic activity, its power is not limited to the regulation only of interstate economic activity, but extends to the regulation of purely intrastate economic activity as well.” Brzonkala v. Va. Polytechnic Inst. & State Univ., 169 F.3d 820, 835 (4th Cir. 1999) (en banc) (emphasis omitted), aff’d sub nom. United States v. Morrison, 529 U.S. 598 (2000).
The Fourth Circuit found that the overall statutory schemes establishing Fannie Mae and Freddie Mac are clearly directed at the regulation of interstate economic activity. Congress created the corporations to “promote access to mortgage credit throughout the Nation” and to foster a nationwide secondary mortgage market. 12 U.S.C. § 1716 (with respect to Fannie Mae); id. § 1451 note (with respect to Freddie Mac). According to the Fourth Circuit, the relevant inquiry was whether the statutory exemptions from state and local taxes are necessary and proper to Congress’s legitimate exercise of its Commerce Clause power. See Raich, 545 U.S. at 34-35 (Scalia, J., concurring).
“[I]n determining whether the Necessary and Proper Clause grants Congress the legislative authority to enact a particular federal statute, courts should look to see whether the statute constitutes a means that is rationally related to the implementation of a constitutionally enumerated power.” United States v. Comstock, 560 U.S. 126, 134 (2010). “The relevant inquiry is simply ‘whether the means chosen are reasonably adapted to the attainment of a legitimate end under the commerce power.’” Id. at 135 (quoting Raich, 545 U.S. at 37 (Scalia, J., concurring) (internal quotation marks omitted)).
The Fourth Circuit held that Congress could rationally have believed that state taxation would substantially interfere with or obstruct the legitimate purposes of Fannie Mae and Freddie Mac of regulating and stabilizing the secondary mortgage market. In addition, the Congressional decision to exempt Fannie Mae and Freddie Mac from most state taxation was a reasonable means of avoiding that risk of interference or obstruction. First, excessive state taxation of Fannie Mae and Freddie Mac could undermine their ability to purchase mortgages by reducing their access to capital. Second, exposure to state taxation would subject Fannie Mae and Freddie Mac to inconsistencies in transaction costs that would vary from state to state. Such a patchwork might undermine the goal of providing mortgage liquidity to all parts of the country. See, e.g., 12 U.S.C. § 1716(4). Third, absent the statutory exemptions, states might be tempted to target Fannie Mae and Freddie Mac with large taxes, given the sheer volume of their mortgage portfolios and their statutory obligations to continue purchasing and guaranteeing mortgages throughout the country.
Accordingly, the Fourth Circuit agreed with the district courts that Congress could rationally have believed that insulating Fannie Mae and Freddie Mac from most state taxation would substantially further those entities’ purposes. Thus, the Fourth Circuit held that the statutory exemptions are valid exercises of Congress’s constitutional powers.
The Fourth Circuit next addressed the Counties’ argument that Morrison and Lopez, two Commerce Clause cases, suggest the opposite result, asserting that the transfer taxes here are completely localized and “no more commercial in nature than the activities” that Congress was attempting to regulate in those cases because “[t]axes are not commerce between or among the States.”
As you may recall, in Morrison, the Supreme Court struck down a federal statute that imposed a civil penalty for gender-motivated violence, 529 U.S. at 601-02, and in Lopez, it struck down a federal statute that criminalized possession of a firearm in a school zone, 514 U.S. at 551.
In both of those cases, the Fourth Circuit recognized that the object of Congress’s regulation was intrastate, non-economic activity. See Morrison, 529 U.S. at 613 (“Gender-motivated crimes of violence are not, in any sense of the phrase, economic activity”); Lopez, 514 U.S. at 561 (“[The statute] has nothing to do with ‘commerce’ or any sort of economic enterprise, however broadly one might define those terms”). In contrast, the ultimate goals of the statutory scheme at issue in this case were to stabilize the secondary mortgage market and to promote liquidity in that market, which are quintessentially interstate and economic aims.
Thus, the Fourth Circuit concluded that Congress may exempt Fannie Mae and Freddie Mac from state and local transfer taxes, even though they are collected in the context of intrastate transactions, because the taxes could substantially interfere with or obstruct the constitutionally justified missions of Fannie Mae and Freddie Mac in bolstering the secondary mortgage market.
Finally, the Fourth Circuit briefly addressed the Counties’ remaining arguments for finding the statutory tax exemptions unconstitutional.
First, the Counties argued that the statutory exemptions inappropriately “commandeer” state employees by requiring them “to record deeds from [Fannie Mae and Freddie Mac] free of charge.” See Printz v. United States, 521 U.S. 898 (1997); New York v. United States, 505 U.S. 144 (1992). The federal statutes in question, however, do not impose upon the states or local officers any affirmative obligation. Surely, South Carolina and Maryland could scrap their title recording systems if they so desired. The mere fact that federal statutes give rise to state action does not amount to commandeering. See South Carolina v. Baker, 485 U.S. 505, 514 (1988) (“Any federal regulation demands compliance”).
Second, the Counties argued that Fannie Mae and Freddie Mac are not federal instrumentalities entitled to immunity from state taxation, implying that Congress may only statutorily exempt federal instrumentalities from taxation. The Fourth Circuit was not persuaded, because, absent waiver, federal instrumentalities are immune from state taxation under the Supremacy Clause of the Constitution, regardless of statutory enactment. See New Mexico, 455 U.S. at 735; McCulloch, 17 U.S. at 436. Moreover, the Supreme Court has repeatedly stated that Congress may grant statutory tax immunity broader than what the Supremacy Clause would otherwise provide. See Blaze Constr. Co., Inc., 526 U.S. at 38; New Mexico, 455 U.S. at 737; City of
Detroit, 355 U.S. at 474.
Third and finally, the Counties argued that the statutory exemptions violate the Tenth Amendment. To be sure, the Tenth Amendment reserves to the States powers not granted to Congress. But because the Fourth Circuit held that Congress acted within its Commerce Clause power in granting Fannie Mae and Freddie Mac statutory tax exemptions, the Tenth Amendment is inapplicable. See New York, 505 U.S. at 156 (“If a power is delegated to Congress in the Constitution, the Tenth Amendment expressly disclaims any reservation of that power to the States”).
Accordingly, the Fourth Circuit affirmed the district courts’ rulings.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Admitted to practice law in Illinois
McGinnis Wutscher Beiramee LLP
CALIFORNIA | FLORIDA | ILLINOIS | INDIANA | WASHINGTON, D. C.
NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.
Our updates are available on the internet, in searchable format, at: