Multistate Taxation: U.S. Supreme Court Strikes Down Double-Tax Structure– June 19, 2015

Today many taxpayers earn income in states other than the ones where they reside, which can lead to tax liability in multiple jurisdictions. With laws differing from state to state, determining how much tax is owed in each jurisdiction can be complicated. In a highly anticipated decision, the U.S. Supreme Court addressed how one state taxes its residents’ out-of-state income.

In Comptroller of the State of Maryland v. Wynne, the Court struck down a Maryland tax structure that it found unconstitutionally subjected state residents to double taxation on income earned in other states. Although the Court’s 5-4 ruling, which included four dissenting opinions, addressed only Maryland law, it could ultimately have an impact on taxpayers outside of Maryland who’s state and local governments have similar “double-dipping” taxation schemes.

The Path to the Supreme Court

Maryland imposes personal tax on state residents in the form of a “state” income tax and a “county” income tax. Residents who pay income tax in another jurisdiction for income earned in that jurisdiction are allowed a credit against the state tax but not the county tax. As a result, part of the income earned by a Maryland resident outside of the state’s borders may effectively be taxed twice. Further, nonresidents who earn income from Maryland sources must pay the state income tax, and nonresidents not subject to the county tax must pay a “special nonresident tax” in lieu of the county tax.

A married couple who were Maryland residents earned income from an S corporation that earned income in several states. They claimed an income tax credit on their 2006 state income tax return for taxes paid to 39 other states. The state Comptroller of the Treasury allowed the credit against their state income tax but not against their county income tax, resulting in the assessment of a tax deficiency.

The assessment was affirmed by the Hearings and Appeals Section of the Comptroller’s Office and by the Maryland Tax Court, but the Circuit Court for Howard County reversed on the ground that Maryland’s tax system violated the Commerce Clause of the U.S. Constitution. The Court of Appeals of Maryland affirmed, and the case proceeded to the U.S. Supreme Court.

The Court’s Reasoning

On May 18, 2015, the Supreme Court affirmed the Maryland Court of Appeal’s ruling in favor of the taxpayers. In doing so, it found that Maryland’s failure to allow a credit against the county tax for taxes paid to other states violates the “dormant” Commerce Clause.

The Commerce Clause grants Congress the power to “regulate Commerce . . . among the several States.” The Supreme Court has long held that the Clause’s language contains a feature known as the “dormant Commerce Clause,” which prohibits states from discriminating between transactions on the basis of some interstate element. In other words, a state can’t more heavily tax a transaction that crosses state lines than one that occurs entirely within the state, nor can it subject interstate commerce to “multiple taxation.”

Justice Samuel Alito, who wrote the majority opinion, concluded that, by taxing residents on all of their income without a credit for out-of-state taxes and taxing nonresidents on their income earned in the state, Maryland’s tax structure was inherently discriminatory. The structure, therefore, failed the “internal consistency” test and was invalid.

In their dissenting opinions, Justices Antonin Scalia and Clarence Thomas reiterated their previous arguments that the so-called dormant Commerce Clause doesn’t exist. They also dismissed Justice Alito’s use of the internal consistency test, which the two justices believe was dismantled by a prior decision.

Taxation of Corporations vs. Individuals

The Supreme Court also pointed out that it has long held that states cannot subject corporate income to higher taxes on dollars earned in interstate commerce. It found no reason not to provide similar protections to income earned by individuals, rejecting Maryland’s argument that individuals reap the benefits of local roads, police and fire protection, public schools and health benefits more than corporations do.

The Court observed that corporations use local roads to haul supplies and goods, call on local police and fire departments to protect their facilities, and rely on schools to educate prospective employees. Government services and the availability of good schools can aid businesses in attracting and retaining employees. Thus, the Court stated, “disparate treatment of corporate and personal income cannot be justified based on the state services enjoyed by these two groups of taxpayers.”

Far-reaching Implications?

The Court’s ruling has led Maryland to take dramatic and immediate action to avoid paying millions of dollars in refunds to its discriminated residents. Just weeks after the Supreme Court’s decision, Maryland passed House Bill 72, which included legislation allowing for a credit against a resident’s county income tax for out-of-state income taxes paid beginning with tax year 2015. Interestingly, Maryland’s attorney general has determined that income tax refunds are not required for tax years prior to 2015, which will likely lead to additional litigation.

The Wynne decision could cause waves in other jurisdictions, including Ohio, North Carolina, Pennsylvania, Tennessee and Wisconsin. Several cities also may be affected, such as Detroit, Kansas City, New York, St. Louis and Wilmington. The decision ultimately may lead to tax code amendments and perhaps even the issuance of refunds, while other jurisdictions likely will consciously avoid passing future laws that may double-dip on out-of-state income.

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