On May 18, 2015, the United States Supreme Court issued its long-awaited decision inComptroller of Treasury of Maryland v. Wynne, No. 13-485 (U.S. May 18, 2015), finding that Maryland’s personal income tax scheme violates the dormant Commerce Clause. Although the decision did not come as a surprise to many state and local tax practitioners, the Court’s 5-4 opinion shredded several arguments frequently advanced by taxing authorities attempting to push the boundaries of the Commerce Clause.
Like most states, Maryland raises revenue by taxing, among other things, personal income. The income tax that the state imposes on its residents, however, has two parts: a “state” income tax, and a “county” income tax. The state income tax is a graduated tax, whereas the county income tax varies by county. Both taxes are administered by the state.
Maryland also has a complementary two-part tax on the income of nonresidents. Nonresidents pay the “state” tax on income earned from sources within Maryland, and a “special nonresident tax” is levied in lieu of the “county” tax on income earned from sources within Maryland at a rate equal to the lowest county income tax rate set by a Maryland county.
If a Maryland resident pays income tax to another taxing jurisdiction for income earned there, then the resident is allowed a credit against the “state” income tax, but not the “county” tax. Thus, income earned by Maryland residents outside the state may be taxed twice—once by the jurisdiction where the income was earned, and again by Maryland’s “county” income tax.
In this case, the Wynnes are residents of Maryland who earned income not only in Maryland, but in 39 other states as well. On their 2006 Maryland tax return, the Wynnes claimed an income tax credit for income taxes paid to other states. The Maryland State Comptroller allowed the Wynnes a credit against their Maryland “state” income tax, but not against their “county” income tax. The Wynnes appealed, but lost at the administrative level and at the Maryland Tax Court. A Circuit Court, however, reversed those decisions on the ground that Maryland’s personal income tax scheme violated the Commerce Clause, and the Court of Appeals affirmed.
On review, the Supreme Court found that Maryland’s personal income tax scheme was in violation of the dormant Commerce Clause, because it ran afoul of the internal consistency test as articulated in Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175 (1995). In essence, the internal consistency test helps identify tax schemes that discriminate against interstate commerce by looking to the structure of the tax to see whether its identical application by every state would favor intrastate commerce over interstate commerce. Here, the Court found that if every state followed Maryland’s income tax scheme by fully taxing the income residents earn both in state and in other jurisdictions, as well as the income nonresidents earn in the state, then interstate commerce would be burdened if a full credit was not allowed for taxes paid to other jurisdictions because out-of-state income by Maryland’s residents would be subject to double taxation. In other words, there would be a disincentive to earn interstate income because that income would be taxed in Maryland as well as the other jurisdiction. Thus, Maryland’s tax scheme violates the dormant Commerce Clause because it places a burden on interstate commerce.
In reaching this decision, the Court addressed many arguments familiar to tax practitioners. For example, although the dissent attempted to distinguish the existing line of dormant Commerce Clause cases from the instant case because they involved taxes on gross receipts rather than net income, the majority soundly rejected the argument that the Commerce Clause distinguishes between taxes on net and gross income.
The Court also addressed the reputed argument that the Commerce Clause imposes no limitation at all on a state’s right to tax the income of its residents because states have a sovereign power to tax all of the income of its residents—no matter where that income is earned. The Court explained that although a state may have the jurisdictional power to impose a tax, that tax may nevertheless be invalid if it violates the Commerce Clause.
Interestingly, the Court not only found that Maryland’s tax scheme was inherently discriminatory, but that it operates as a tariff as well. According to the Court, this “identity between Maryland’s tax and a tariff is fatal because tariffs are ‘[t]he paradigmatic example of a law discriminating against interstate commerce.’” Thus, even though Maryland argued that, due to the credit for the “state” portion of the income tax, it actually receives less tax revenue from residents who earn income from interstate commerce than those who earn only intrastate income, the Court noted that the critical point is that the total tax burden on interstate commerce is higher than that on intrastate commerce. The fact that Maryland may receive more or less tax revenue is not the relevant issue.
Naturally, the fallout from the Court’s decision in Wynne has yet to be seen. Although Maryland could bring its tax scheme into compliance in a number of ways, it would be prudent for affected taxpayers in Maryland to file claims for refund for all open years. Plus, taxpayers affected by similar tax schemes in other states (e.g., New York, Pennsylvania, Indiana, and Ohio) are advised to consult a tax professional to secure potential refunds in those states as well.