Seventh Circuit Decides En Bank That Tax Injunction Act Precludes Constructive Trust Over Riverboat Casino Tax

27 July 2011 Second City Bench Memo Publication
Authors: Jonathan W. Garlough

Following a rare vote to vacate a prior panel opinion and rehear en banc the question of the Tax Injunction Act’s application to a claim for a constructive trust over nearly $200 million in taxes collected to assist the Illinois horseracing industry, the Seventh Circuit held that the TIA precluded federal courts from enjoining the disbursement of the tax proceeds to Illinois racetracks. In Empress Casino Joliet Corp., et al. v. Balmoral Racing Club, Inc., No. 09-3975 (7th Cir. July 8, 2011), the Seventh Circuit held, by a 5-3 vote, that a surcharge assessed against riverboat casinos and directed for use by Illinois racetracks was a “tax” subject to the Tax Injunction Act’s prohibition against federal district courts to “enjoin, suspend, or restrain the assessment, levy or collection of any tax under State law.” 28 U.S.C. § 1341. (Disclosure: Foley & Lardner represents intervening tracetracks before the district court and Seventh Circuit).

In 2006, after finding that the horse racing industry had been damaged by the advent of riverboat gambling and that the racing industry was beneficial to the state’s economy, the Illinois General Assembly passed Public Act 94-804, which assessed a 3% tax on riverboat casinos whose 2004 adjusted gate receipts (“AGR”) exceeded $200 million. The 2006 Act was set to expire after two years. In 2008, the General Assembly renewed the 2006 Act for three additional years, again affecting the same four upstate riverboat casinos.

The four upstate riverboat casinos affected by the 2006 Act challenged its constitutionality in the Illinois state courts. On direct appeal to the Illinois Supreme Court, the court rejected the casinos’ challenge to the Act, holding unanimously that the Act complied with the Illinois Constitution’s uniformity, due process and takings clauses.

Following former Governor Blagojevich’s indictment, the riverboat casinos filed a RICO complaint in the Northern District of Illinois, alleging that the 2006 and 2008 acts were the product of a “corrupt bargain” and seeking a constructive trust over the tax proceeds to prevent their distribution to the horseracing industry. After a hearing on the riverboats’ motion for preliminary injunction, District Judge Matthew Kennelly held that the riverboats’ request to enjoin the disbursement of the tax funds was prohibited by the Tax Injunction Act, 28 U.S.C. § 1341.

On appeal, a divided panel of the Seventh Circuit disagreed. Judge Sykes, joined by Judge William Bauer, held that the 3% surcharge was a “fee” rather than a “tax,” and thus not subject to the limitations o f the Tax Injunction Act. Judge Richard Posner dissented, pointing out that the tax and earmarking elements of the Illinois tax were commonplace and that the allocation of the casino tax funds in a separate account was of no impact for classifying the exaction as a tax.

On the racetracks’ petition for rehearing en banc, the full Seventh Circuit (minus Judges Ann Williams, Joel Fluam, and Ilana Rovner, each of whom was recused) vacated the panel’s opinion. Following oral argument on May 10, 2011, a majority of the Court reversed its prior ruling and held that the casino surcharge was a “tax” within the meaning of the Tax Injunction Act, and thus federal courts were precluded from enjoining the disbursement of the tax’s proceeds. Writing for the five-member majority, Judge Posner explained:

The fact that the casino exaction isn’t called a tax, is placed in a trust fund, passes speedily from taxpayer to recipient, is justified by referenced to the police power of the state rather than the state’s taxing power, etc., has nothing to do with any concern behind the Tax Injunction Act. “Taxation” is unpopular these days, so taxing authorities avoid the term. Legislatures are unpredictable, so trust funds are created to hold revenues generated by specific taxes, in order to avoid annual appropriations battles. The politics of state taxation have naught to do with the policy of the Tax Injunction Act. If in the guise of “interpreting” the Act the courts insist on greater candor or directness in state taxing legislation as the price for avoiding federal-court suits to enjoin state tax collections, we shall make it difficult, given the politics of tax-and-spending legislation, for states to raise revenues – we shall be doing just what the Supreme Court in Rosewell said it was the object of the Act to prevent doing: throwing state tax administration in disarray.

Although the majority held the Tax Injunction Act barred the enjoinment of the casino tax, the Court extended the current stay over the disbursement of the tax proceeds for an additional 30 days to permit the riverboats time to petition the United States Supreme Court for the same injunctive relief.

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