A personal income tax case that at first blush appears quite simple has had many twists and turns. However, more interesting than its rise through the Maryland courts is that the U.S. Supreme Court agreed to hear a case where Maryland courts had ruled in favor of the taxpayer. After much anticipation, the U.S. Supreme Court issued its 5–4 decision on May 18, holding that Maryland's tax scheme violates the "dormant" Commerce Clause by discriminating against interstate commerce (Wynne, No. 13-485 (U.S. 5/18/15)).
The Facts
Brian and Karen Wynne were married with five children and were Maryland residents. In 2006, the Wynnes reported income from wages earned in Maryland, and Brian Wynne received income from an S corporation, Maxim Healthcare Services Inc. As residents, the Wynnes were subject to Maryland personal income tax on all their income.
The Wynnes then claimed a state tax credit on their Maryland personal income tax return for Brian Wynne's share of income taxes paid to the 39 other states where Maxim conducted business. Maryland Code Tax-General Section 10-703(a) provides that "a resident may claim a credit only against the State income tax for a taxable year . . . for state tax on income paid to another state for the year."
The Maryland personal income tax return levies both a state income tax and a county income tax. The county tax rates vary, and the tax rate applied is based on a taxpayer's county of residence. Nonresidents are also subject to the Maryland county income tax, at the lowest county rate. The Wynnes resided in Howard County during 2006. The matter of contention between the parties was that in addition to taking a tax credit against Maryland state income tax for taxes paid to other states, the Wynnes claimed a credit for taxes paid to other states against their Howard County income tax.
The Comptroller of Maryland determined that the Wynnes improperly claimed a county tax credit and issued an assessment. The Wynnes appealed to the Hearings and Appeals Section of the Comptroller's Office, which affirmed that the tax credit for taxes paid to other states was limited to Maryland state taxes and not available to offset Howard County taxes. The Wynnes next appealed to the Maryland Tax Court and argued that the limitation violated the dormant Commerce Clause of the U.S. Constitution. The Maryland Tax Court upheld the Comptroller's denial of a Howard County credit for taxes paid to other states.
Upon appeal to the state Circuit Court for Howard County, that court reversed the Maryland Tax Court's decision and held that Maryland's disallowance of a tax credit violated the dormant Commerce Clause (Wynne v. Maryland State Comptroller, No. 13-C-10-80987 (Md. Cir. Ct. 6/29/11)).
The Comptroller appealed to the Court of Appeals (Maryland's highest state court), which affirmed the circuit court's decision and found that the failure to provide a credit against the county income tax violated the dormant Commerce Clause because it discriminated against interstate commerce (Maryland Comptroller v. Wynne, 431 Md. 147 (2013)).
The Comptroller submitted a request for reconsideration to the Court of Appeals, which denied the motion but issued a stay on the effective date, pending the Comptroller's timely petitioning the U.S. Supreme Court for a writ of certiorari (Maryland Comptroller v. Wynne, 424 Md. 291 (2013)). The Comptroller timely petitioned, and certiorari was granted on May 27, 2014.
Matter Before the U.S. Supreme Court
The Supreme Court considered whether the dormant Commerce Clause can limit a state's ability to tax all the income of its residents even when a portion of their income is taxed in another state.
The Commerce Clause authorizes Congress to "regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes" (U.S. Constitution, Article I, §8, cl. 3). "Though phrased as a grant of regulatory power to Congress, the [Commerce] Clause has long been understood to have a 'negative' aspect that denies the States the power unjustifiably to discriminate against or burden the interstate flow of articles of commerce" (Oregon Waste Systems, Inc. v. Department of Environmental Quality, 511 U.S. 93, 98 (1994)). The Commerce Clause is often referred to as "dormant" because in practice it provides the ability to restrict state powers, versus the explicit language of the law that grants Congress a power to act.
Wynnes' arguments: The Wynnes argued that the application of the Maryland county income tax, by not allowing a credit for taxes paid to other states, discriminates against interstate commerce in violation of the dormant Commerce Clause.
The Supreme Court held in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977), that a state may tax interstate commerce under the dormant Commerce Clause so long as the tax satisfies a four-prong test. The Complete Auto test provides that a state law withstands Commerce Clause scrutiny if it:
1. Applies to an activity with a substantial nexus with the taxing state;
2. Is fairly apportioned;
3. Does not discriminate against interstate or foreign commerce; and
4. Is fairly related to the services provided by the state.
The Wynnes conceded they had substantial nexus and received services from Howard County, as required under prongs 1 and 4.
However, the Wynnes argued the county income tax does not satisfy prongs 2 and 3. Maryland residents are subject to tax on 100% of their income. The disallowance of a credit for taxes paid to other states creates double taxation; hence it is not fairly apportioned, as required in prong 2. By not also allowing a credit for taxes paid to other states, the state taxes individuals (such as the Wynnes) who earn income in interstate commerce at a higher rate than a similar individual with passthrough income earned only in Maryland. The Wynnes argued this violates prong 3 by discriminating against interstate commerce, similarly to the Court's decision in Fulton Corp. v. Faulkner, 516 U.S. 325 (1996).
In Fulton Corp. v. Faulkner, the U.S. Supreme Court ruled that North Carolina's intangibles tax violated the dormant Commerce Clause because it discouraged "domestic corporations from plying their trades in interstate commerce." North Carolina levied an intangibles tax on the value of corporate stock owned by North Carolina residents. The tax rate was gradually reduced based on the amount of corporate income subject to North Carolina tax. Under this taxing structure, a North Carolina resident owning companies that performed their business outside North Carolina would be taxed at a higher rate than a similar resident who owned companies operating wholly within North Carolina.
Comptroller's arguments: The Comptroller argued against the use of the dormant Commerce Clause to regulate the taxation of its own residents. The Comptroller contended that Maryland may tax all of resident individuals' income solely due to their status as residents, even if it double-taxes income earned outside the state, citing Oklahoma Tax Commission v. Chickasaw Nation, 515 U.S. 450 (1995).
Chickasaw Nation recognized that states "sometimes elect not to" exercise the full extent of their "authority to tax all income of their residents" and may instead choose to "credit income taxes paid to other sovereigns," and the decision to do so "is an independent policy decision." The Comptroller, in the writ of certiorari, argued that a credit for taxes paid is not mandated by the courts, but, rather, a state affords these rights at its discretion.
The Comptroller argued that Maryland's county taxes are not discriminatory, due to their consistent application (e.g., a Maryland resident pays tax only to one Maryland county) and because they are necessary to provide public services, such as education, police, and fire protection (see Oklahoma Tax Commission v. Jefferson Lines, Inc., 514 U.S. 175 (1995), and New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937)).
The Comptroller also argued that allowing a tax credit against the county income tax for taxes paid to other states discriminates against Maryland residents who earn all their income within Maryland and remit county income tax on all income. Residents who earn all of their income within Maryland would pay disproportionately more for the benefits afforded to them than Maryland residents with income taxed outside the state who take a credit for taxes paid.
The Comptroller reasoned that resident individuals can voice their opinions on laws they find offending by using their right to vote (citing Goldberg v. Sweet, 488 U.S. 252, 266 (1989)). Furthermore, the dormant Commerce Clause has never been used to protect resident individuals from their own state's tax, since they have voting powers that corporations and nonresidents do not possess.
Decision
The Supreme Court agreed with the Wynnes that by not allowing a credit against the county tax for taxes paid to other states, the Maryland personal income tax scheme discriminated against interstate commerce and violated the dormant Commerce Clause. The Court determined that the "so-called" Maryland county income tax was effectively a state tax. Applying the internal consistency test, the Court concluded that if each state adopted a taxing scheme similar to Maryland's, "interstate commerce would be taxed at a higher rate than intrastate commerce." Thus, the Maryland tax scheme operates like a tariff because it provides an incentive to earn income in Maryland and not outside Maryland. The Court has ruled in previous decisions that state tariffs directly violate the dormant Commerce Clause.
Three dissenting opinions were issued or joined by four justices. The principal dissent claimed that several of the cases relied on by the majority (J.D. Adams Mfg. Co. v. Storen, 304 U.S. 307 (1938); Gwin, White & Prince, Inc. v. Henneford,305 U.S. 434 (1939); and Central Greyhound Lines, Inc. v. Mealey, 334 U.S. 653 (1948)) considered the taxation only of gross receipts from interstate commerce and not a tax on the net income of a business. The Comptroller also argued that the cases did not apply because they concerned the taxation of corporations only, not individuals. However, the majority rejected both of these arguments, stating that these prior court cases addressed the threat of multiple taxation, which is not limited to gross receipts taxes or applicable only to corporations.
The Comptroller further argued that states should have a free hand to tax the out-of-state income of resident individuals (as opposed to corporations) because states provide many services to their residents. The court found that this argument failed because corporations also benefit heavily from state and local services. As the court noted, corporations rely on local roads to transport their goods, local police and fire to protect their facilities, and local schools to educate and retain good employees.
The Comptroller and the principal dissent also pressed the argument that because resident individuals have a right to vote to change the law, they therefore do not need protection from their own state's taxes. The Court found that if a tax unconstitutionally discriminated against interstate commerce, it was invalid regardless of who was challenging it, pointing out that the Court had "entertained and even sustained dormant Commerce Clause challenges by individual residents of the State that imposed the alleged burden on interstate commerce" and had "also sustained such a challenge to a tax whose burden was borne by in-state consumers" (Wynne, slip op. at 11).
The majority also addressed the principal dissent's argument that the Commerce Clause does not limit a state's ability to tax income of its residents wherever it is earned. That may be true of the Due Process Clause (Fifth and Fourteenth Amendments), but not the Commerce Clause, the majority stated, quoting Quill Corp. v. North Dakota, 504 U.S. 298, 305 (1992): "[W]hile a state may, consistent with the Due Process Clause, have the authority to tax a particular taxpayer, imposition of the tax may nonetheless violate the Commerce Clause." The majority determined that while Maryland has the right under the Due Process Clause to impose its county income tax, the Court must still strike down a tax if it violates the dormant Commerce Clause by increasing the tax burden on interstate commerce.
Impact of the Court's Ruling
The Court's decision in Wynne will likely effect change beyond the borders of Maryland. A handful of states impose a county or local income tax, which must now be revisited to determine whether it violates the dormant Commerce Clause and whether taxpayers are entitled to an additional credit for taxes paid to other states.
One such opportunity may lie in a previously decided case, In the Matter of John Tamagni v. Tax Appeals Tribunal of the State of New York, 91 N.Y.2d 530 (1998). The New York Court of Appeals held that the taxpayer, who was a resident of New Jersey but established a statutory residency in New York, was not entitled to relief for paying income taxes on intangible income to both New Jersey and New York. In its decision, the Court of Appeals maintained that the dormant Commerce Clause did not apply to personal income taxes. In light of the Wynne decision, not only must New York's state tax scheme be reevaluated, but also New York City's tax scheme, which does not allow for a credit for taxes paid to other jurisdictions.
The state and/or local taxing schemes employed by Indiana, Ohio, Tennessee, Wisconsin, and many others will likely face similar challenges. And while many taxpayers may evaluate opportunities to file protective refund claims, they must prepare for a lengthy court battle. States are likely to exhaust all measures to hold onto the money in their coffers. States may also begin modifying their laws to avoid future Commerce Clause challenges. The Wynne decision should lead to many more lively debates and undoubtedly alter the landscape of state and local taxation.
EditorNotes
Anthony Bakale is with Cohen & Company Ltd. in Cleveland. For additional information about these items, contact Mr. Bakale at 216-774-1147 or tbakale@cohencpa.com. Unless otherwise noted, contributors are members of or associated with Cohen & Company Ltd.
