In the 1986 case West Virginia v. United States, the Supreme Court ruled on a dispute over federal tax deductions for state and local taxes. The State of West Virginia had claimed that it was entitled to deduct certain taxes paid to other states from its gross income for federal tax purposes. However, the Internal Revenue Service (IRS) disagreed with this interpretation and denied these deductions. The Supreme Court sided with the IRS in a unanimous decision, ruling that under Section 164(a)(3) of the Internal Revenue Code, only individuals or corporations are allowed to claim such deductions - not states themselves. Therefore, West Virginia's claims were invalid as they did not fall within any category specifically mentioned in Section 164(a). This decision upheld an earlier ruling by a lower court which also found against West Virginia. This case clarified how federal law applies to state taxation practices and confirmed that states cannot use their status as sovereign entities to avoid paying full amounts owed under federal tax laws.

In the dissenting opinion for West Virginia v. United States, 1986, Justice O'Connor disagreed with the majority's interpretation of federal law and its impact on state tax policy. She argued that Congress did not intend to prevent states from taxing federal contractors differently than other businesses when it passed a statute prohibiting discriminatory taxes against them. The justice believed that this misinterpretation could potentially disrupt state tax systems by forcing them to treat all businesses equally regardless of their different circumstances or contributions to the local economy. Furthermore, she expressed concern about how this ruling might affect future cases involving similar issues and urged her colleagues to reconsider their decision in light of these potential consequences.