State & Local Tax Alert Breaking state and local tax developments from Grant Thornton LLP ________________________________________________________ U.S. Supreme Court Holds Lack of County Personal Income Tax Credit for Taxes Paid to Other States Violates Commerce Clause On May 18, the U.S. Supreme Court held in Comptroller of the Treasury v. Wynne that the failure of Maryland law to allow a credit against county personal income tax for Maryland residents for their pass-through income from an S corporation’s out-of-state activities that was taxed by other states was unconstitutional.1 In affirming the judgment of the Maryland Court of Appeals by a 5-4 decision, the U.S. Supreme Court held that the Maryland tax system impermissibly exposed taxpayers to the possibility of double taxation. Also, the Maryland tax system was held to violate the fair apportionment requirement of the dormant Commerce Clause because it failed the internal consistency test. This test supported the conclusion that Maryland’s tax method was inherently discriminatory and operated as a tariff. Background
The Wynne case developed from the issues that often arise when taxpayers earn income from multistate businesses and attempt to rely upon the credit for taxes paid to other states in order to prevent duplicative levels of state and local taxation. The taxpayers, a married couple residing in Howard County, Maryland, held an ownership interest in a federal S corporation providing nationwide health care services. On both their 2006 federal and Maryland income tax returns, the taxpayers reported a portion of the S corporation’s income as “pass-through income.” On their Maryland return, the taxpayers claimed a credit against their personal income tax for taxes paid to other states. The S corporation filed state income tax returns in 39 different states and allocated to each shareholder a pro rata share of taxes paid. Maryland’s credit for taxes paid to other states is distinctive given that the structure of the income tax is directed to two separate levels of government. Maryland imposes a personal income tax on its residents that is comprised of a “state” income tax that is set at
U.S. Supreme Court, No. 13-485, May 18, 2015. Justice Alito delivered the opinion of the Court and was joined in the decision by Justices Roberts, Kennedy, Breyer and Sotomayor. Justice Ginsburg filed a dissenting opinion, in which Justices Scalia and Kagan joined. Justices Scalia and Thomas each filed dissenting opinions, and joined in each other’s dissents. .
Release date May 26, 2015 States Maryland Issue/Topic Personal Income Tax Contact details Matthew Melinson Philadelphia T 215.376.6050 E [email protected]
John Stine Philadelphia T 215.814.4030 E [email protected]
Vito Cosmo Philadelphia T 215.701.8839 E [email protected]
Gary Rosen McLean T 703.637.4070 E [email protected]
Jeremy Jester McLean T 703.847.7505 E [email protected]
Jamie C. Yesnowitz Washington, DC T 202.521.1504 E [email protected]
Chuck Jones Chicago T 312.602.8517 E [email protected]
Lori Stolly Cincinnati T 513.345.4540 E [email protected]
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a graduated rate2 and a “county” income tax that is set a rate that varies by county.3 While the two taxes are designated as state and county taxes, both of these taxes are actually collected by the state, with the county tax then being disbursed to the counties. If Maryland residents earn income in another state and pay income tax to the other state, Maryland law allows them a credit against the “state” income tax, but not the “county” income tax.4 Maryland also imposes a two-part personal income tax on nonresidents. First, nonresidents must pay the “state” income tax on all of the income that they earn from sources within Maryland.5 Second, nonresidents that by definition cannot be a resident of a Maryland county and would not be subject to the county tax must pay a “special nonresident tax” instead of the county tax.6 The Maryland Comptroller only allowed the taxpayers to apply the credit against their state income tax, disallowing the credit against the county income tax and resulting in the issuance of an assessment. The Hearings and Appeals Section of the Comptroller’s Office and the Maryland Tax Court subsequently affirmed the assessment. However, the Circuit Court for Howard County reversed the assessment and held that Maryland’s tax system violated the dormant Commerce Clause. Maryland Court of Appeals Decision
The Maryland Court of Appeals, the state’s highest court, affirmed the Howard County Circuit Court and concluded that the Maryland tax system was unconstitutional to the extent that it denied the taxpayers a credit against the county tax for income taxes they paid to other states.7 In reaching its decision, the Maryland Court of Appeals applied the four-part test specified by the U.S. Supreme Court in Complete Auto Transit v. Brady8 that a statute must satisfy to survive a Commerce Clause challenge. The following four-prong test must be considered in determining the constitutionality of a state tax statute: (i) the tax must be applied to an activity with a substantial nexus with the taxing state; (ii) the tax must be fairly apportioned; (iii) the tax must not discriminate against interstate commerce; and (iv) the tax must be fairly related to the services provided by the state. The Court of Appeals held that the tax failed both the fair apportionment and nondiscrimination parts of this test. The tax did not satisfy the fair apportionment requirement because it failed both the internal and external consistency tests. The internal consistency test was violated because if every state adopted Maryland’s tax system, interstate commerce would be taxed at a higher rate than intrastate commerce. The external consistency test was violated because it created a risk of multiple taxation. Also, the tax discriminated against interstate commerce because the interstate income earned by residents was taxed at a higher rate than income earned intrastate. The Comptroller appealed this decision and following 2
MD. CODE ANN., TAX-GEN § 10-703. MD. CODE ANN., TAX-GEN §§ 10-103; 10-106. The county rate may not exceed 3.2 percent, which is imposed by several populous localities, including the city of Baltimore, Montgomery County and Prince Georges County. 4 MD. CODE ANN., TAX-GEN § 10-105(a). 5 MD. CODE ANN., TAX-GEN § 10-105(d). 6 MD. CODE ANN., TAX-GEN § 10-106.1. The rate of this tax equals the “lowest county income tax rate set by any Maryland county,” which is currently 1.25 percent. 7 Maryland State Comptroller v. Wynne, 64 A.3d 453 (Md. 2013). For a detailed discussion of this case, see GT SALT Alert: Maryland Court of Appeals Rules Denial of County-Level Tax Credit for Taxes Paid to Other States Violates Commerce Clause. 8 430 U.S. 274 (1977). 3
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intervention by the U.S. Solicitor General’s office urging a hearing at the U.S. Supreme Court, certiorari was granted. Dormant Commerce Clause Violated
The U.S. Supreme Court affirmed the Maryland Court of Appeals and held that the lack of a credit against the county income tax violated the dormant Commerce Clause. In reaching its decision in Wynne, the Court noted that the Commerce Clause grants Congress the power to “regulate Commerce . . . among the several States.”9 This is phrased as a positive grant of power to Congress, but the Court has “consistently held this language to contain a further, negative command, known as the dormant Commerce Clause, prohibiting certain state taxation even when Congress has failed to legislate on the subject.”10 The Court acknowledged that “this interpretation of the Commerce Clause has been disputed,” but that “it also has deep roots.” According to the Court, “[b]y prohibiting States from discriminating against or imposing excessive burdens on interstate commerce without congressional approval, it strikes at one of the chief evils that led to the adoption of the Constitution, namely, state tariffs and other laws that burdened interstate commerce.”11 Under the dormant Commerce Clause, a state may not “impose a tax which discriminates against interstate commerce either by providing a direct commercial advantage to local business, or by subjecting interstate commerce to the burden of ‘multiple taxation.’”12 Three Key Double Taxation Decisions The Court explained that “[o]ur existing dormant Commerce Clause cases all but dictate the result reached in this case by Maryland’s highest court.” To support its decision, the Court discussed three cases that concerned taxing the income of domestic corporations.13 In J.D. Adams Manufacturing Co. v. Storen,14 Indiana taxed the income of a local corporation on sales made outside the state. The Court held that this tax system violated the dormant Commerce Clause because it taxed receipts from interstate commerce without apportionment and with the risk of double taxation. In Gwin, White & Prince, Inc. v. Henneford,15 Washington taxed a local corporation’s income that was earned from shipping fruit to other states and foreign countries. The Court held that this method of taxation discriminated against interstate commerce because there was a risk of multiple taxation that did not exist for the intrastate sales. Finally, New York attempted to tax the portion of a local bus company’s gross receipts from services provided in neighboring states in Central Greyhound Lines, Inc. v. Mealey.16 The Court held that this tax placed an unfair burden on interstate commerce because other states might attempt to tax these same gross receipts.
U.S. CONST. art. I, § 8, cl. 3. Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 179 (1995). 11 Citing Fulton Corp. v. Faulkner, 516 U.S. 325, 330-331 (1996); Hughes v. Oklahoma, 441 U.S. 322, 325 (1979); Welton v. Missouri, 91 U.S. 275, 280 (1876). 12 Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 458 (1959) (citations omitted). 13 The Court acknowledged that these were gross receipts tax cases rather than income tax cases. 14 304 U.S. 307 (1938). 15 305 U.S. 434 (1939). 16 334 U.S. 653 (1948). 10
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In Wynne, the Court explained that each of these prior cases “struck down a state tax scheme that might have resulted in the double taxation of income earned out of the State and that discriminated in favor of intrastate over interstate economic activity.” According to the Court, Maryland’s tax system was unconstitutional for similar reasons. Internal Consistency Test Although the Court did not use the “internal consistency test” terminology in the three cases discussed above, the Court held that the tax systems in these cases could be cured by taxes that satisfy what currently is known as the “internal consistency test.” This test is used to identify tax systems that discriminate against interstate commerce. Specifically, the test “looks to the structure of the tax at issue to see whether its identical application by every State in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate.”17 The Court explained that “[b]y hypothetically assuming that every State has the same tax structure, the internal consistency test allows courts to isolate the effect of a defendant State’s tax scheme.” The internal consistency test was formally introduced by the Court more than 30 years ago18 and has been applied in seven cases that reached the Court. In three of these cases, application of the test invalidated the tax.19 The Court held that the Maryland tax system failed the internal consistency test. To support its conclusion, the Court supplied a simple hypothetical example, under which every state imposes the following taxes: (i) a 1.25 percent tax on income that residents earn in the state; (ii) a 1.25 percent tax on income that residents earn in other jurisdictions; and (iii) a 1.25 percent tax on income that nonresidents earn in the state.20 The example also assumes that two taxpayers, April and Bob, both live in State A, but that April earns all of her income in State A and Bob earns all of his income in State B. In this example (which does not contain a credit mechanism similar to the one Maryland provides) Bob would be subject to double taxation and pay more income tax than April solely because he earns income in State B. April would be subject to the tax imposed by State A described in (i), while Bob would be subject to the tax imposed by State A described in (ii), as well as a tax imposed by State B described in (iii), given that under the hypothetical example as constructed by the Court, all states impose the same tax system. Based on this example, the Court concluded that Maryland’s tax system is inherently discriminatory and operates as a tariff. However, as discussed below, the principal dissent disagreed with the application of this test.
Jefferson Lines, Inc., 514 U.S. 175. See Container Corp. v. Franchise Tax Board, 463 U.S. 159 (1983). 19 See American Trucking Assns., Inc. v. Michigan Pub. Serv. Comm’n, 545 U.S. 429 (2005); Jefferson Lines, Inc., 514 U.S. 175; Goldberg v. Sweet, 488 U.S. 252 (1989); American Trucking Assns., Inc. v. Scheiner, 483 U.S. 266 (1987); Tyler Pipe Industries v. Department of Revenue, 483 U.S. 232 (1987); Armco, Inc. v. Hardesty, 467 U.S. 638 (1984); Container Corp., 463 U.S. 159. 20 In the hypothetical example, the tax described in (i) is comparable to the Maryland county-level tax on residents earning income inside Maryland. The tax described in (ii) is comparable to the Maryland county-level tax on residents earning income outside Maryland. The tax described in (iii) is comparable to the special nonresident tax imposed by Maryland. 18
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Court Addresses Principal Dissent’s Arguments
A large portion of the Court’s opinion in Wynne addressed and rejected the arguments raised by what was termed the “principal dissent” issued by Justice Ginsburg and joined by Justices Scalia and Kagan. In the principal dissent, Justice Ginsburg argued that Maryland’s ability to tax the income earned by its residents should not be limited, explaining that this “decision veers from a principle of interstate and international taxation repeatedly acknowledged by this Court: A nation or State ‘may tax all the income of its residents, even income earned outside the taxing jurisdiction.’”21 According to the principal dissent, the Court abandoned “principles and precedent sustaining simultaneous residence- and source-based income taxation” by holding that under the dormant Commerce Clause, a state “is not really empowered to tax a resident’s income from whatever source derived.” As explained by the principal dissent, “nothing in the Constitution or in prior decisions of this Court dictates that one of two States, the domiciliary State or the source State, must recede simply because both have lawful tax regimes reaching the same income.” The principal dissent concluded that the Court decided to strike down Maryland’s tax system because: (i) the tax creates a risk of double taxation; and (ii) the tax is “inherently discriminatory” as a result of failing the internal consistency test. According to the principal dissent, the first reason is “overwhelmed by the history . . . of States imposing and this Court upholding income taxes that carried a similar risk of double taxation.” In rejecting the second reason, the principal dissent noted that “[t]his Court has not rigidly required States to maintain internally consistent tax regimes.” Double Taxation The principal dissent explained that “domicile” has long been recognized as a secure basis for taxing a resident’s worldwide income. Because residents receive more benefit from their state than nonresidents, states may demand more from their residents. Also, residents have political means (for example, the power of the vote) to ensure that the state does not abuse its taxing power. As asserted by the principal dissent, “[s]tates deciding whether to tax residents’ entire worldwide income must choose between legitimate but competing tax policy objectives.” A state can prioritize seeking equal contributions for taxpayers that receive similar benefits or prioritize that taxpayers are not subject to double taxation, but it cannot do both. The principal dissent illustrated this by noting that taxpayers who earn all of their income in Maryland would owe the same taxes to Maryland as the taxpayers in Wynne who earned part of their income from outside the state. In this way, under the current taxing system, taxpayers who receive similar benefits from Maryland would pay the same tax to the state. However, if the county income tax credit is provided to prevent possible double taxation, taxpayers earning part of their income outside Maryland would pay less tax to Maryland than taxpayers who earned all of their income within Maryland. In some cases, where taxpayers earn income primarily outside Maryland, this difference could be substantial. The right to balance between these two objectives has belonged to the states or Congress, but according to the principal dissent, not to the Supreme Court.
Oklahoma Tax Comm’n v. Chickasaw Nation, 515 U.S. 450, 462-463 (1995) (emphasis in original).
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As explained by the principal dissent, the Court has issued a ‘”long series” of decisions that allowed states to tax both residents’ worldwide income and nonresidents’ in-state income. In fact, the “Court specifically affirmed that the exact same ‘income may be taxed [simultaneously] both by the state where it is earned and by the state of the recipient’s domicile.’”22 In response to the majority opinion, the principal dissent stated that “it is incorrect that support for this principle is limited to the Court’s Due Process Clause cases.” The principal dissent cited to Shaffer v. Carter,23 in which the Court rejected both a Due Process Clause challenge and a dormant Commerce Clause challenge of Oklahoma laws that taxed residents on all worldwide income and nonresidents on all in-state income, but without providing a credit to residents or nonresidents for income tax paid outside the state. Also, the Court’s decision in West Publishing Co. v. McColgan reinforced this decision.24 In West Publishing, the Court summarily rejected an argument that a California tax violated the dormant Commerce Clause because it subjected interstate commerce to double taxation. In addressing the principal dissent, the Court explained that “[t]his argument confuses what a State may do without violating the Due Process Clause of the Fourteenth Amendment with what it may do without violating the Commerce Clause.” The Due Process Clause allows a state to tax all of the income of its residents, but imposition of the tax may violate the Commerce Clause. According to the Court, the principal dissent was “unable to identify a single case that endorses its essential premise, namely, that the Commerce Clause places no constraint on a State’s power to tax the income of its residents wherever earned.” The Court determined that “[t]he principal dissent, if accepted, would work a sea change in our Commerce Clause jurisprudence.” The Court noted that the principal dissent cited only two cases, Shaffer and West Publishing, which are supposedly inconsistent with Wynne. According to the Court, in Shaffer, the dormant Commerce Clause challenge was nothing like the challenge in Wynne. The taxpayer in Schaffer did not rely on a double taxation argument but instead argued that states may not impose a tax “directly” on interstate commerce. Thus, Schaffer “did not adjudicate anything like the double taxation argument that was accepted in later cases and is before us today.” West Publishing was entitled to less precedential value because it was a summary affirmance. Also, the Court did not disagree with the result of West Publishing because the tax was only levied on income from sources within the state. Thus, the tax system in West Publishing was internally consistent and nondiscriminatory. Three Key Double Taxation Decisions The principal dissent emphasized that the three cases relied on by the Court, J.D. Adams, Gwin, and Central Greyhound, concerned gross receipts taxes rather than income taxes. The principal dissent thought this distinction to be important, as the Court historically has held the differences between these taxes require different results under the Commerce Clause. In Wynne, the Court explained that “this historical point is irrelevant” and the Court’s
Curry v. McCanless, 307 U.S. 357, 368 (1939) (emphasis added by dissenting opinion). 252 U.S. 37 (1920). 24 382 U.S. 823 (1946). 23
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“cases rejected this formal distinction some time ago,” acknowledging the similarities of these taxes. The Court also rejected the Comptroller’s argument that the three cases did not apply to Wynne because they concerned the taxation of corporations rather than individuals. The Court stated that the dormant Commerce Clause should not treat individuals less favorably than corporations. Individuals and corporations both greatly benefit from state and local services. The Court also dismissed the argument that corporations should receive less protection because only individuals are allowed to vote. If a state’s tax unconstitutionally discriminates against interstate commerce, it does not matter whether the taxpayer is a resident voter or nonresident. Internal Consistency Test The principal dissent contended that the “Court has not rigidly required States to maintain internally consistent tax regimes.” Before Wynne, for the past two decades, the Court has not required that a tax pass the internal consistency test.25 Furthermore, it has been nearly 30 years since the Court struck down a state tax for violating the test.26 Also, the Court has rejected challenges to taxes that fail the test. The principal dissent pointed to a “deep flaw” in the Court’s internal consistency test. While the Court describes internal consistency as a “cure,” the principal dissent noted that this does not necessarily solve the double taxation issue. Under the Court’s reasoning, the internal consistency test is violated because Maryland simultaneously imposes the county income tax and the special nonresident tax. Maryland could cure the internal consistency defect by repealing the special nonresident tax, or by providing nonresidents a credit for taxes paid to other jurisdictions based on Maryland source income, but doing so would not allow the taxpayers in Wynne to escape double taxation. To illustrate its point, the principal dissent addressed the Court’s hypothetical example concerning April and Bob discussed above. According to the principal dissent, each state does not need to use the same method to make its tax system internally consistent. For example, State A could choose to only tax residents’ worldwide income by eliminating tax (iii), the tax on nonresidents’ in-state income. State B could decide exclusively to tax income earned within the state by eliminating tax (ii), the tax on residents’ out-of-state income. The tax burden on April and Bob would not change. Without a credit mechanism, April would still pay tax (i), and Bob would still pay tax (i) and tax (ii). The principal dissent completed its critique of the example by concluding that a state could somehow satisfy the internal consistency test proposed by the Court by simply eliminating tax (iii), the tax imposed on a nonresident taxpayer. In the principal dissent’s view, the Court’s “cure” is “no match for the perceived disease.” In response, the Court countered that the “Maryland scheme’s discriminatory treatment of interstate commerce is not simply the result of its interaction with the taxing schemes of other States.” According to the Court, the “internal consistency test reveals what the
See Jefferson Lines, Inc., 514 U.S. 175. See American Trucking Assns., Inc., 483 U.S. 266; Tyler Pipe Industries, 483 U.S. 232.
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undisputed economic analysis shows: Maryland’s tax scheme is inherently discriminatory and operates as a tariff.” The Court rejected the principal dissent’s contention that there are other tax systems that result in double taxation but do not violate the internal consistency test. In prior cases, the Court considered and rejected this argument.27 The Court also rejected the argument that by offering a credit against the “state” portion of the tax, Maryland receives less tax revenue from residents who earn income from interstate commerce than residents who earn income from intrastate commerce. The Court determined that this is a “red herring” because “[t]he critical point is that the total tax burden on interstate commerce is higher, not that Maryland may receive more or less tax revenue from a particular taxpayer.” After rejecting the principal dissent’s various arguments, the Court was left with two arguments against the internal consistency test “that are inconsistent with each other and with our precedents.” First, the principal dissent claimed that a state that imposes a tax based on residence must “recede” to a state that imposes a tax based on source. The Court responded that it did not establish this rule of priority. Maryland could satisfy the internal consistency test by allowing a credit against county tax for taxes that residents pay to other states, but it also could comply with the Commerce Clause in some other way. Second, the principal dissent’s concern with the possibility that Maryland could eliminate the inconsistency by terminating the special nonresident tax (which would not benefit the taxpayers in Wynne) was a tacit admission that a Maryland tax based on residence does not need to “recede” to another state’s decision to tax based on source. Finally, the Court noted that the principal dissent’s concern is a truism of every case arising under the dormant Commerce Clause, as a state can cure a tax violation by either “leveling up” or “leveling down” tax rates. Other Dissents Reject Dormant Commerce Clause Theory
Justices Scalia and Thomas issued separate dissents that rejected the concept of a dormant Commerce Clause. In a dissent joined in part by Justice Thomas, Justice Scalia criticized the dormant Commerce Clause cases and stated that Wynne illustrates the error. Justice Scalia explained that the fundamental problem with the dormant Commerce Clause cases is that the Constitution does not contain such a clause and does not mention prohibiting state laws that burden interstate commerce. Also, a “glaring defect” of the dormant Commerce Clause is its lack of governing principle. Accordingly, “[t]he internal consistency rule invoked by the Court nicely shows our ad hocery.” Furthermore, Justice Scalia opined that the dormant Commerce Clause lacks stability. Finally, the dormant Commerce Clause is not compatible with the conventional judicial function. Instead, the Court is required to balance the needs of commerce against the needs of state government. Justice Scalia only would invalidate a tax under the dormant Commerce Clause if “it discriminates on its face against interstate commerce or cannot be distinguished from a tax this Court has already held unconstitutional.” Justice Thomas issued a separate dissent joined in part by Justice Scalia that similarly criticized the dormant Commerce Clause. According to the dissent, Wynne proves the extent to which the dormant Commerce Clause has departed from the actual Commerce
Armco, 467 U.S. 638.
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Clause. Justice Thomas doubted that the majority’s application of one of the dormant Commerce Clause tests was correct under case law, but was certain that majority’s result was incorrect under the Constitution. Commentary
Grant Thornton has been following developments in this case closely, as five of the authors of this SALT Alert attended the oral arguments at the U.S. Supreme Court on November 12, 2014. Also, two of the authors are Maryland residents who are directly affected by (and undoubtedly supportive of) this decision. This significant, complex decision involving a variety of Commerce Clause principles and competing interests is predicted to have a large financial impact on the state of Maryland and potentially other states with similar local income taxes that may not allow a credit for taxes paid to other states. As indicated by the fact that this was a 5-4 decision, and three justices joined in a comprehensive dissent that was extensively addressed by the Court, the constitutionality of the Maryland tax system was not clear. The Court affirmed the Maryland Court of Appeals’ decision, but did not discuss the appropriate remedies for taxpayers. However, based on this decision, Maryland ultimately is expected to issue an estimated $200 million in tax refunds to the taxpayers and a group of similarly situated Maryland residents.28 Also, this decision is estimated to reduce the tax revenue of Maryland (more specifically, Maryland counties) by $42 million annually on a prospective basis.29 In light of the fact that the U.S. Supreme Court does not consider state and local income tax cases very often, cases such as Wynne are very significant, providing a window into how the Court (and the three dissenting opinions) view these matters and potentially influencing the views of state tax authorities, legislatures, practitioners and taxpayers. An interesting place to start is the failure of the Court and the three dissents to even agree on matters of terminology. For example, the Court determined that the Maryland tax system “operates as a tariff.” The principal dissent notes that this is a “curious claim” because the “defining characteristic of a tariff is that it taxes interstate activity at a higher rate than it taxes the same activing conducted within the State.” According to the principal dissent, Maryland’s resident income tax does the opposite because it taxes the income of the residents at the same rate whether it is earned in or outside the state. Also, the Court repeatedly refers to the Maryland tax system as a “scheme” but the principal dissent seems to disfavor this terminology. Note that the Court and the principal dissent use the terminology of dormant Commerce Clause but the dissents by Justices Scalia and Thomas refer to this as the negative Commerce Clause. This comports with the language in Justice Scalia’s dissent that the “negative” Commerce Clause is a “judicial fraud.” These distinctions in language do not seem to be accidental. Moving on to more substantive issues, one of the most interesting aspects of this case is the Court’s express statement that a state that imposes a tax based on residence is not
Bill Turque, Supreme Court: Maryland Has Been Wrongly Double-Taxing Residents Who Pay Income Tax to Other States, THE WASHINGTON POST, May 18, 2015. This estimate appears to be based on the refund claims that have already been filed with the Maryland Comptroller. Because some Maryland residents may not have been aware of the litigation, or chose to wait until the U.S. Supreme Court’s decision until commencing the process to file refund claims, this final amount may be greater. 29 Id.
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required to “recede” to a state that imposes a tax based on source. There are ways that Maryland could satisfy the internal consistency test without providing the relief that the taxpayers in Wynne requested, which was a credit for taxes paid to other states against the state and county components of the Maryland income tax. For example, if Maryland repealed the special nonresident tax, internal consistency could be cured, though instances of double taxation could still exist in the future. Conceivably, a local taxing jurisdiction could decide to only tax residents. This would pass the internal consistency test but still could result in double taxation. However, because it passes the internal consistency test, this tax system would not be prohibited under the Court’s reasoning. Because the Maryland Court of Appeals struck down this taxing system over two years ago, the state has had the opportunity to prepare for the possibility that the U.S. Supreme Court would affirm the Wynne decision. On April 13, 2015, the final day of the Maryland legislative session, the Maryland General Assembly passed legislation, the Budget Reconciliation and Financing Act of 2015, which includes provisions that address this case.30 According to the Maryland General Assembly’s Web site, this legislation has not been transmitted to the governor for approval.31 The legislation, if enacted, would require the Maryland Attorney General to review the decision and advise the Comptroller and the Maryland Department of Legislative Services whether the decision invalidates the practice under Maryland law of allowing, for state tax on income paid to another state, a credit only against the state income tax.32 If the Attorney General advises that the statute is invalidated, a statutory amendment that would extend the credit to the county income tax33 would apply to taxable years beginning after December 31, 2014. Otherwise, the statutory amendment would not take effect. Under this legislation, the Attorney General also would be required to review the U.S. Supreme Court’s decision in Wynne and advise whether the decision requires the payment of income tax refunds and interest attributable to taxable years beginning after December 31, 2005 and before January 1, 2015.34 If the Attorney General determines that the state must pay the refunds, the law further provides for the state funds that would be used to pay the refunds. Local governments would be required to reimburse the state for their share of related refunds and interest. Thus, the cost of refunds will fall on the state as well as local governments. If this legislation is enacted, we expect that the Attorney General will advise that the existing statute is invalidated given the Court’s judgment and analysis.35 The Comptroller likely will wait until the Attorney General actually makes an affirmative statement to release guidance concerning the filing of refund claims based on Wynne.
H.B. 72, as passed by Maryland House and Senate on April 13, 2015. It should be noted that to date, no special legislative session has been scheduled for this year, potentially calling into question when this legislation will be transmitted to the governor. 32 H.B. 72, § 26. If the governor does not approve this legislation, the Attorney General presumably would have the independent authority to address and potentially resolve the refund issue. 33 MD. CODE ANN., TAX-GEN § 10-703. 34 H.B. 72, § 27. 35 Query what would happen if the Attorney General somehow decided that the Maryland statute was not invalid in light of Wynne, or determined that the relief requested in Wynne was only applicable to a portion of the class of taxpayers similarly situated to the taxpayers in Wynne. We raise this issue not as a prediction that something of this nature will occur, but as something to watch. 31
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The amount of interest that the state must pay on refund claims of this type is somewhat uncertain. The interest rate for refunds generally is 13 percent for 2015.36 However, legislation enacted in 2014 requires the Comptroller to lower the interest rate for refunds as a result of Wynne.37 Specifically, the Comptroller is directed to set the annual rate for an income tax refund that is a result of the final decision under Wynne at a percentage that equals the average prime rate of interest quoted by commercial banks to large businesses during fiscal year 2015, based on a determination by the Board of Governors of the Federal Reserve Bank. This would result in an interest rate of 3.25 percent. The Attorney General has approved this provision,38 but one can expect that the interest rate change may be challenged, particularly by high-income taxpayers that have preserved their rights by filing protective refund claims for several years. Although this case concerns a Maryland statute, Wynne may have an impact on the laws of other states such as New York, Ohio and Pennsylvania that impose both state and local income taxes. For example, New York City does not have a personal income tax credit for taxes paid to other states. Many Ohio cities provide a local personal income tax credit for taxes paid to another municipality but not for taxes paid to another state. In Pennsylvania, the city of Philadelphia does not offer a credit for taxes paid to other states for purposes of calculating the city’s net wage tax. As a result, some localities may need to reevaluate and possibly change their income tax systems to ensure that they do not permit the double taxation of income in a manner that would violate the principles espoused in Wynne. This may lead to refund claims or require legislative action, and may result in unintended revenue shortfalls as is likely to be the case in Maryland. This case will likely impact the interplay and administration of state and local tax laws for many years to come.
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General Notice, Maryland Comptroller of the Treasury, Oct. 17, 2014. Ch. 464 (S.B. 172), § 16, Laws 2014. 38 Review Letter, Maryland Attorney General, May 14, 2014. 37