The U.S. Court of Appeals for the Third Circuit recently confirmed that Fannie Mae, Freddie Mac and the Federal Housing Finance Agency are exempt from paying transfer taxes to state and local governments when buying and selling foreclosed properties.
In so holding, the Court rejected arguments from local governments that: (1) their transfer taxes fell within the statutory exception for taxation of real property, and (2) the tax exemptions exceeded Congressional authority under the Commerce Clause and infringed upon the 10th Amendment.
A copy of the opinion can be found at: http://www2.ca3.uscourts.gov/opinarch/132163p.pdf
This appeal is a consolidation of three District Court actions brought by various counties in Pennsylvania and New Jersey (“Appellants”), against Federal National Mortgage Association (“Fannie”), Federal Home Loan Mortgage Corporation (“Freddie”), and the Federal Housing Finance Agency (“FHFA”) (collectively, the “Enterprises”).
The Appellants filed suit against the Enterprises seeking judicial declaration that the Enterprises are not exempt from paying state and local real estate transfer taxes. The cases were dismissed by the District Courts and consolidated for appellate review by the Third Circuit.
As you may recall, Fannie and Freddie are federally-chartered but privately owned corporations that issue publically traded securities. Congress created Fannie and Freddie to establish and stabilize the secondary markets for residential mortgages to promote access to mortgage credit. In the wake the housing market collapse of 2008, Fannie and Freddie owned a significant number of defaulted and overvalued subprime mortgages and went bankrupt. On July 30, 2008, Congress created the FHFA to act as conservator for Fannie and Freddie.
Under their charters, Congress exempted the Enterprises from “all taxation” by any state or local government, with the exception to taxes on real property. See 12 U.S.C. § 1723a(c)(2) [Fannie]; 12 U.S.C. § 1452(e) [Freddie] ; 12 U.S.C. § 4617(j)(2) [FHFA].
Pennsylvania and New Jersey, like many other states, tax the transfer of real estate. Pennsylvania imposes a tax on the recording of transfers of real estate. See 72 Pa. Cons. Stat. Ann. § 8102-C and D. New Jersey imposes similar taxes on recording of deeds and transfers of real property. See N.J. Stat. Ann. § 46:15-7a.
The Appellants challenged the tax exemptions to the Enterprises under two arguments. First, Appellants argued that state and local transfer taxes fall within the statutory exception for taxes on real property. Second, the tax exemption exceeded Congress’s power under the Commerce Clause and infringed upon the 10th Amendment.
In rejecting the Appellants’ statutory challenge, the Court determined that transfer taxes are not direct taxes but rather an excise tax, or an indirect tax. Thus, the state and local transfer taxes do not fall within the exception for direct taxes on real property.
Appellants relied on United States v. Wells Fargo Bank, 485 U.S. 351 (1988), where Wells Fargo sought a refund of estate taxes paid on tax-free financing instruments issued by state and local housing authorities under the Housing Act of 1937. The court in Wells Fargo Bank explained that Housing Act was passed to exempt property from direct taxation, but certain privileges of ownership, such as the right to transfer the property, could be taxed.
In rejecting the Appellants’ reliance on Wells Fargo Bank, the Court explained that Wells Fargo Bank involved an exemption of specific property from all taxation. The estate tax at issue was an excise tax on the transfer of property at death, whereas here, the tax emptions at issue involved exemptions of taxation on entities. Thus, the distinction between a property exemption and an entity exemption renders Wells Fargo Bank inapposite.
The Court relies instead on Federal Land Bank of St. Paul v. Bismarck Lumber Co., 314 U.S. 95 (1941), which considered whether a provision of the Federal Farm Loan Act that exempted Federal Land Banks from paying state taxes included a state sales tax on property. The relevant portion of the Farm Loan Act stated “[t]hat every Federal land bank . . . shall be exempt from Federal, State, municipal, and local taxation.” Id. at 99. Bismark held that the term “taxation” used in the Farm Loan Act clearly encompassed a sales tax such as the one at issue. Id.
As the Court explained, the exemption in Bismark is materially identical to the Enterprise exemptions in two important ways. First, the exemption applied to entities and not to specific property, unlike the exemption in Wells Fargo Bank. Second, a sales tax is an excise or privilege tax different in kind from a tax on real property. Thus, both taxes are taxes on the privilege of transferring ownership of property and not taxes on the property itself.
The Third Circuit also considered similar contentions rejected by the Sixth, Seventh and Eighth Circuits, and agreed with its sister circuits. Accordingly, the Court held that the phrase “all taxation” means the Enterprises are statutorily exempt from paying state and local real estate transfer taxes.
The Court then considered whether the tax exemptions to the Enterprises exceeded Congress’s power under the Commerce Clause and violated the 10th Amendment.
The Third Circuit easily reached its conclusion as to the first argument because the Supreme Court has firmly established the authority of Congress to regulate economic activity under the Commerce Clause. The Enterprises were created to buy mortgages from banks and pump money into the banking industry that could be used to make additional loans. Thus, Congress could have rationally believed that exempting the Enterprises from the burden of state and local taxation would allow them to pursue their directives.
Although the Appellants attempted to shift the analysis away from the economic nature of the secondary mortgage market by arguing that the collection of taxes is not economic activity but rather the sovereign rights of states, the argument was flatly rejected. The transfer tax exemption aids the Enterprises in regulating the secondary mortgage market, which is clearly economic in nature and in any event, considerations of state sovereignty must yield under the Supremacy Clause. Accordingly, the Court held that Congress acted well within the bounds of the Commerce Clause in exempting the Enterprises from paying state and local real estate transfer taxes.
Lastly, the Third Circuit considered Appellants’ contention that by requiring states and local governments to register deed transfers involving the Enterprises at no cost, Congress violated the anti-commandeering principal of the 10th Amendment. In the Court’s own words, the “argument is frivolous.”
Looking to the only two Supreme Court cases that found a federal statute to unlawfully commandeer state government actors, the common thread in those cases involved imposing an affirmative obligation on state and local officials, which is not the case with the exemptions to the Enterprises.
In Printz v. United States, the Supreme Court invalidated a federal statute requiring state and local law enforcement officers to perform background checks on prospective handgun purchasers, holding that the 10th Amendment precludes Congress from commanding state executive officers to administer and enforce a federal regulatory scheme. Printz v. United States, 521 U.S. 898 (1997).
In New York v. United States, the Supreme Court struck down a provision of a federal regulatory regime involving the disposal of low-level radioactive waste by the states, whereby states were required to take title to the waste if they failed to arrange for disposal by a specified date. New York v. United States, 505 U.S. 144 (1992).
In this case, the tax exemptions to the Enterprises do not require states and local governments to administer or enforce a federal regulatory program. A state official’s compliance with federal law and non-enforcement of a preempted state law— as required by the Supremacy Clause – is not an unconstitutional commandeering.
Accordingly, the Third Circuit held that the statutory language “all taxation” includes within its scope state and local real estate transfer taxes, and the exemption for real property taxation does not apply to transfer taxes. The Court further held that Congress acted within its constitutional authority in granting the Enterprises such immunity.
The Third Circuit affirmed the orders of the District Courts dismissing Appellants’ complaints.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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