South Carolina does not illegally tax federal retirees’ pensions, the S.C. Supreme Court said Monday in a ruling that could have cost the state millions in income tax refunds.

The justices unanimously said South Carolina has complied with a 1989 U.S. Supreme Court ruling in a Michigan case that said states could no longer tax state and federal retirees’ pensions differently.

S.C. officials had warned that the state could be forced to pay more than $200 million in income tax refunds going back to 1995, and would lose another $22.5 million a year in future income taxes if the state Supreme Court sided with federal retiree Doris Stieglitz Ward, who sued the state.

“It makes a difference to the state’s pocketbook,” said lawyer Vance Bettis, who represented the state, when contacted Monday.

Ward can appeal to the U.S. Supreme Court, Bettis said. Neither Ward nor her lawyer, Cam Lewis, could not be reached Monday.

Ward, who filed her lawsuit in 1998 in Richland County, sued on behalf of herself and other affected federal retirees. There are an estimated 65,000 federal retirees and more than 94,000 state retirees in South Carolina.

The state paid about $75 million to about 62,000 federal retirees from 1994-1996 to settle a separate, related lawsuit.

Before the 1989 U.S. Supreme Court ruling, South Carolina levied income taxes on federal retirees’ pensions but exempted state retirees’ pay.

After the ruling, the S.C. Legislature started taxing state retirees’ pensions. But, at the same time, lawmakers raised state pensions by 7 percent — the state income tax rate.

That move, in effect, gave “tax rebates” to state retirees, discriminating against federal retirees, Ward said in court papers.

But the S.C. Supreme Court disagreed in its ruling Monday.

“A state is entitled to raise the level of taxable compensation of its employees if it so chooses,” Associate Justice E.C. Burnett wrote for the court. “(The 1989 ruling) requires that the state tax federal and state retirees equally and does not concern itself with the manner in which a state chooses to compensate its retirees.”

A separate, related case involving state retirees will be heard next month by a state administrative law judge, Bettis said.

In that case, state retirees claim that the state broke a contract with them when it started taxing their pensions in 1989. A ruling favoring them could cost up to $300 million in refunds, state officials estimate.

Reach Brundrett at (803) 771-8484 or rbrundrett@thestate.com.