The City of Manassas, the site of two major battles of the Civil War, is involved in yet another conflict with the U.S. government.

At issue is a Virginia law that allows Manassas to tax federal equipment used by the city's largest employer, IBM. The law was declared unconstitutional recently by a federal appeals court, but the city has decided to fight. Last week, city officials took steps to ask the U.S. Supreme Court to overturn the ruling.

If the Supreme Court rejects the appeal, Manassas could lose an annual source of revenue and would be forced to pay back to the United States a levy that has totaled $600,000 since 1981.

City officials say they are concerned that the loss in funds could affect much-needed capital improvements in a rapidly growing community of 20,500.

"In next year's budget, a one-penny increase on the property tax would equal about $100,000," said City Manager John Cartwright.

"The city is trying to move ahead with a major capital improvements plan {$87 million over six years if approved}. We hate to lose any revenue source, especially when you look at the loss of federal funds such as revenue sharing and how the state continues to mandate services without providing the funds to do so."

Cartwright added that the suit has statewide implications because Manassas is not the only local government that applies the tax. The State of Virginia has intervened in the suit in support of Manassas.

Federal officials argue that the state law must be challenged because it could set a potentially significant financial precedent.

"The tax is unconstitutional," said Richard Correa, trial attorney for the tax division of the Justice Department. "The U.S. doesn't pay unconstitutional taxes and is entitled to a refund of its money. It is very important to establish that local governments cannot treat the U.S. differently than its own subparts and contractors."

What the legal battle becomes is a case of who has a right to tax whom.

The city maintains that it is levying a legal "rise tax" on IBM. Virginia state law allows localities to tax businesses for profits received on some normally tax-exempt products -- with the exception of the Virginia Port Authority and local transportation districts.

IBM contracted with the U.S. Navy in 1980 to produce and research sonar equipment. Under the deal, the Navy would provide the materials and equipment for the research. IBM would provide the expertise.

The city claimed that IBM made a profit from the deal and should be taxed. So the city commissioner of revenue taxed the profit IBM made on the contract, using as a basis for his figure the depreciated value of the Navy equipment, said James W. Hopper, a Richmond lawyer handling the case for the city.

Beginning in 1981, IBM began paying the tax in protest. But the corporate giant later passed the tax it paid as a cost in the contract. So in effect, the federal government began paying the tax, officials said.

The Justice Department filed suit in June 1985 challenging Manassas and the Virginia law with two arguments:That the law discriminates against the federal government because it did not tax the Virginia Port Authority and the transportation districts.

That the property should not have been taxed at full value and that in essence the city is taxing the federal government.

At issue, federal officials said, is the supremacy rule. The Justice Department notes that in McCulloch v. Maryland (1819), the Supreme Court struck down a Maryland tax on notes of the Bank of the United States.

The federal government's suit was first heard by a federal district judge in Alexandria who ruled in favor of the city. The 4th U.S. Circuit Court of Appeals overturned the lower court's ruling, prompting the city to prepare an appeal to the Supreme Court. According to Hopper, the city has spent $12,000 in legal fees.

He said the case would be argued before the nation's highest court about a year from now.