The Three-Part Test That Determines if a Local Government Can Legally Charge an Impact Fee

On June 26, 1987, inside the United States Supreme Court, Justice Antonin Scalia delivered a ruling that fundamentally altered how local governments fund public infrastructure. The case, Nollan v. California Coastal Commission, began when James and Marilyn Nollan sought a permit to replace their 504-square-foot beachfront bungalow in Ventura County with a 2,500-square-foot home. The state commission agreed to issue the permit, but only on the condition that the Nollans dedicate a public easement across their private beach. Scalia struck down the demand, writing that unless the condition directly mitigated a harm caused by the new home, the government's action was an out-and-out plan of extortion.[4][5]

That decision laid the groundwork for what is now the definitive legal standard governing how municipalities charge developers for growth. As federal infrastructure grants declined through the 1970s and 1980s, local governments increasingly turned to development impact fees—one-time charges levied on new construction to pay for roads, sewers, and schools. By shifting the financial burden of new infrastructure from existing property taxpayers to developers, these fees became a cornerstone of municipal finance.[1][5]

Because impact fees are imposed as a condition of receiving a building permit, they sit at the volatile intersection of municipal finance and the Fifth Amendment's Takings Clause. To differentiate a valid regulatory fee from an illegal, unapportioned tax, courts and state legislatures have developed a strict three-part test. This framework dictates exactly what a local government must prove before it can legally charge an impact fee.[2][4][6]

The first part of the test is the threshold question of unconstitutional conditions. Before analyzing the fee itself, courts ask whether the government's demand would constitute an illegal taking of property if it were imposed entirely outside the permitting process. If a city council simply demanded that a landowner hand over $23,420 or dedicate a strip of land for a public park without any associated development application, it would clearly violate the Fifth Amendment. Because the demand is leveraged against a permit approval, the burden immediately shifts to the municipality to justify the exaction.[4][6]

The second part of the test requires the government to establish an essential nexus. Originating directly from the 1987 Nollan decision, this prong demands a direct, logical connection between the fee imposed and the specific public need generated by the proposed development. If a developer builds a 500-unit subdivision that will demonstrably increase traffic on an adjacent arterial road, a traffic impact fee possesses the essential nexus. If, however, the municipality attempts to use that same fee to cure pre-existing city-wide congestion or build a facility miles away, the nexus is broken and the fee becomes an unconstitutional taking.[1][4][6]

The third part of the test, established in the 1994 Supreme Court case Dolan v. City of Tigard, requires rough proportionality. It is not enough for a municipality to prove that a development creates a need for infrastructure; the amount of the fee must be proportionally related to the exact scale of the development's impact. A local government cannot charge a single-family homebuilder for the cost of upgrading a regional water treatment plant if that home only accounts for a fraction of a percent of the new capacity requirement.[4][5][6]

At the state level, this federal constitutional floor is frequently operationalized through statutory frameworks like the dual rational nexus test. In Florida, for example, legislative analyses of impact fee bills explicitly require municipalities to prove two distinct connections. First, there must be a rational nexus between the new construction and the need for additional capital facilities. Second, there must be a rational nexus between the expenditure of the collected funds and the benefits accruing specifically to the new development.[2]

To satisfy this dual requirement, local governments must specifically earmark impact fee revenues. The funds cannot be deposited into a general municipal account or used to pay down existing municipal debt for previously approved projects. They must be spent on capital facilities that directly benefit the new residents who ultimately bear the cost of the fee.[2][6]

The rigor of this three-part test forces municipalities to rely on highly specific, localized data rather than arbitrary estimates. When calculating fees, cities frequently hire specialized consultants to conduct comprehensive nexus studies. These studies quantify the exact cost per unit of capacity—whether it is gallons of wastewater treated per day or the number of vehicle trips generated per household—ensuring the final fee schedule aligns with the rough proportionality requirement.[1][5][6]

The application of these fees becomes particularly complex in shared-ownership structures, creating a structural bottleneck for municipal finance. Legal analyses of development impact fees often intersect with property governance thresholds. For instance, in condominium developments, state laws frequently require 67 percent to 80 percent unit owner approval to amend declarations or alter common elements. When a municipality attempts to pass through a maximum allowable 50 percent impact fee hike onto a shared-ownership property undergoing redevelopment, apportioning that cost requires navigating these rigid supermajority voting thresholds—a conflict between municipal taxation limits and private governance rules.[2][3][6]

State legislatures are increasingly stepping in to cap how aggressively these fees can scale, even when the three-part test is met. Recent legislative efforts in Florida, such as Senate Bill 1301 in the 2025 session, have sought to codify the dual rational nexus test while imposing strict limits on fee hikes. Under such frameworks, an impact fee increase cannot exceed 50 percent of the current rate, and municipalities are barred from raising the fee more than once every four years, barring extraordinary circumstances.[2]

The scope of the three-part test was recently reaffirmed and expanded by the Supreme Court in 2024. In Sheetz v. County of El Dorado, a property owner challenged a $23,420 traffic impact fee that was mandated by a county-wide legislative schedule rather than an ad-hoc administrative decision. The Court unanimously ruled that the Takings Clause does not distinguish between legislative and administrative permit conditions. Consequently, even broadly applied, legislatively-adopted impact fees must survive the essential nexus and rough proportionality tests.[6]

The enforcement of this three-part test remains the primary legal mechanism balancing municipal infrastructure needs against housing affordability. While impact fees successfully shield existing taxpayers from the costs of new growth, developers routinely capitalize the fees into the final cost of construction, driving up home prices for new buyers. By requiring a strict, quantifiable link between the fee charged and the impact created, the courts ensure that local governments cannot use the permitting process as a backdoor to general taxation.[4][5][6]