## Facts

- Michigan created the Michigan Education Trust (MET) by statute in 1986 to accept prepaid tuition payments, invest them, and later pay tuition at Michigan public colleges and universities for designated beneficiaries.
- The enabling statute labeled MET a “public body corporate and politic” and a “public instrumentality of the state,” placed it within the Department of Treasury, and vested governance in a board that operated independently of the department.
- MET’s only income sources were participant contract payments and investment earnings on those funds.
- Michigan did not pledge its full faith and credit to MET and had no legal duty to cover MET’s obligations if the trust became insolvent.
- MET sought IRS guidance; the IRS treated MET as a taxable corporation and MET paid federal income tax on its investment income.
- MET later filed refund claims for those taxes; after the IRS did not grant the refunds, Michigan and MET sued, asserting no federal statute imposed income tax on MET’s investment earnings.

## Issues

1. Whether any provision of the Internal Revenue Code imposed federal income tax on MET’s investment income.
2. Whether MET should be treated as a taxable “corporation” (or other taxable entity) under the Code, or as a state instrumentality not taxed absent clear congressional direction.

## Decision

- The Sixth Circuit reversed the district court.
- The court held that, although Congress has authority to tax a state instrumentality’s investment income, the Code as written did not impose such a tax on MET’s investment earnings.
- The case was remanded for proceedings consistent with the conclusion that MET’s investment income was not federally taxable.

## Legal Principles

- Federal taxing power over state instrumentalities may be exercised, but courts require clear statutory authorization before construing the Internal Revenue Code to tax a state agency or instrumentality.
- A state-created entity’s corporate form does not, by itself, establish federal income tax liability where state law designates the entity as a public instrumentality and the Code does not clearly include it within taxable entity provisions.
- When the Code contains specific provisions addressing taxation of certain state-related entities, the absence of similarly specific coverage for a particular state instrumentality supports a conclusion that Congress did not tax it.

## Conclusion

The Sixth Circuit concluded that MET functioned as a state instrumentality and that the Internal Revenue Code did not clearly subject MET’s investment income to federal income tax; accordingly, the court reversed the judgment imposing tax and remanded.


State of Michigan v. United States, 40 F.3d 817 (6th Cir. 1994)