## Facts

- Congress enacted I.R.C. § 86 to tax up to one-half of Social Security benefits for taxpayers whose income exceeds specified thresholds ($32,000 for joint filers; $25,000 for most others).
- Section 86 calculates “modified adjusted gross income” by adding adjusted gross income, tax-exempt interest (including municipal bond interest), and one-half of Social Security benefits.
- If the modified figure exceeds the threshold, a portion of Social Security benefits becomes includable in gross income, subject to a statutory cap.
- The City of New York and its Comptroller sued the Secretary of the Treasury, alleging that counting tax-exempt municipal bond interest in the § 86 formula effectively taxes municipal bond interest and raises municipal borrowing costs.
- The City sought declaratory and injunctive relief, asserting violations of intergovernmental tax immunity and the Tenth Amendment.
- The district court denied the City’s summary-judgment motion and dismissed the complaint under Rule 12(b)(6); the City appealed.

## Issues

1. Whether I.R.C. § 86 violates intergovernmental tax immunity by using tax-exempt municipal bond interest to determine the taxable portion of Social Security benefits.
2. Whether I.R.C. § 86 violates the Tenth Amendment by impairing state and local borrowing through an alleged increase in municipal bond financing costs.

## Decision

- The Second Circuit affirmed dismissal for failure to state a claim.
- The court held § 86 imposes a tax on Social Security benefits received by private taxpayers, not a direct tax on municipal bond interest or on the City.
- Any adverse effect on municipal borrowing was an indirect economic consequence insufficient to trigger intergovernmental tax immunity.
- The court held the Tenth Amendment does not bar a generally applicable federal income-tax provision directed at private income merely because it may incidentally affect state or local finances.

## Legal Principles

- Intergovernmental tax immunity prohibits federal taxes that directly burden a state or its instrumentalities, but not generally applicable taxes whose effects on state interests are indirect or incidental.
- Congress may consider tax-exempt income in a statutory formula used to compute a different federal tax without thereby converting the measure into a tax on the exempt income itself.
- The Tenth Amendment does not invalidate an otherwise authorized federal tax on private parties merely because it may indirectly increase state or local borrowing costs.

## Conclusion

The court sustained I.R.C. § 86 against constitutional challenge, concluding that including tax-exempt municipal bond interest in the computation for taxing Social Security benefits does not constitute a direct tax on municipal securities and does not impermissibly intrude on state sovereignty.


Goldin v. Baker, 809 F.2d 187 (2d Cir. 1987)