Supreme Court Says Portion of Maryland Tax Law Unconstitutional

May 18, 2015

Comptroller v. Wynne, et ux., No. 13-485, 2015 U.S. LEXIS 3404 (U.S. Sup. Ct. May 18, 2015)


Overview

The U.S. Supreme Court, on May 18, struck down a Maryland tax law that essentially hits Maryland residents with a double tax on income earned outside of Maryland.  The Court’s opinion has implications not just for Maryland residents impacted by the tax but also for residents in other states that are subject to the same taxing scheme, including Iowa. 

Facts of the Case

Maryland’s personal income tax system is comprised of a state income tax and a “county tax.” The “county tax” is, in reality, a state tax collected by the state rather than the counties.  Maryland residents who earn income outside the state of Maryland and pay tax on that income to those other jurisdictions can claim a tax credit against the Maryland state tax that they pay, but not any Maryland county tax.  Thus, some of the income earned by Maryland residents is effectively taxed twice.

Note:  Non-Maryland residents with Maryland-source income pay the Maryland state income tax and non-residents that aren’t subject to the county tax pay a “special non-resident tax” in lieu of the “county” tax.The taxpayers were Maryland residents that had income passed-through to them from an S corporation.   The S corporation did business in multiple states which generated income attributable to those non-Maryland jurisdictions.  On their 2006 returns, the taxpayers claimed an income tax credit for the taxes paid to the other states.  The state of Maryland allowed the credit against Maryland income tax but not against county-level tax and assessed a deficiency.  The Hearings and Appeals Section of the Comptroller’s Office affirmed, as did the Maryland Tax Court on appeal.  On further review, the trial court reversed citing a violation of the Commerce Clause.  That decision was affirmed by the Maryland Court of Appeals which held that the Maryland taxing scheme unconstitutionally discriminated against interstate commerce.  The state of Maryland and the Obama Administration both sought review by the U.S. Supreme Court.

Supreme Court Opinion

The Court, in a 5-4 opinion authored by Justice Alito, held that the Maryland tax scheme violated the dormant Commerce Clause which bars states from discriminating between transactions on the basis of some interstate element.  In other words, the Court said that Maryland could not impose a tax that discriminates against interstate commerce either by providing a direct commercial advantage to local business, or by subjecting interstate commerce to multiple taxation.  Doing so would create an incentive for taxpayers to opt for intrastate rather than interstate economic activity.  That, the Court said, violated the dormant commerce clause.  Under the dormant commerce clause, every state (or subdivision thereof) must give its residents a full tax credit for all income taxes paid in another state (or subdivision thereof).  In this light, the reasoned that the taxpayers’ receipt of Subchapter S pass-through income in Maryland was “interstate commerce” that was substantially effected by Maryland’s tax structure.  That’s what violated the dormant commerce clause.  In addition, the Court said it was immaterial whether the tax was imposed on gross receipts or net income or whether it was imposed on corporations or individuals.  It also didn’t matter, the Court said, that Maryland had the power to impose the tax. 

Justices Scalia, Thomas, Ginsburg and Kagan dissented, writing three separate dissents among them.

Implications

Given that there are thousands of taxing jurisdictions in the U.S., the Court’s opinion could have a significant impact in some states and, more likely, in cities and municipalities.  Often, municipal taxes aren’t treated the same as income taxes when it comes to credits for taxes paid to other states.  In Iowa, for example, the out-of-state tax credit is set forth in Iowa Code §422.8(1) where it refers to tax paid to another state or foreign country.  Iowa Code §4.1(32) defines “state” and says it includes the “District of Columbia and it territories.”  The Iowa Department of Revenue has construed those statutory provisions to mean that the out-of-state tax credit does not offset municipal taxes.  That view will have to change now that it is contrary to the Supreme Court’s opinion.

The Court’s opinion could also mean that some state and local governments could take a fiscal hit.

keywords: comptroller v. waynne, maryland tax law, county tax, non-resident tax, maryland court of appeals, commerce clause, iowa code §422.8(1), iowa code §4.1(32)

 

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