On May 18, the U.S. Supreme Court issued its decision in Comptroller of the Treasury of Maryland v. Wynne. In short, the Court, in a five-to-four decision written by Justice Alito, handed the taxpayer a victory by holding that the county income tax portion of Maryland’s personal income tax scheme violated the dormant U.S. Constitution’s Commerce Clause.
Specifically, the Court concluded that the county income tax imposed under Maryland law failed the internal consistency test under the dormant Commerce Clause, because it is imposed on both residents and non-residents with Maryland residents not getting a credit against that Maryland local tax for income taxes paid to other jurisdictions (residents are given a credit against the Maryland state income tax for taxes paid to other jurisdictions).
The Supreme Court emphatically held (as emphatically as the Court can be in a five-to-four decision) that the dormant Commerce Clause’s internal consistency test applies to individual income taxes. The Court’s holding does create a perilous situation for any state or local income taxes that either do not provide a credit for taxes paid to other jurisdictions or limit the scope of such a credit in some way.
The internal consistency test—one of the methods used by the Supreme Court to examine whether a state tax imposition discriminates against interstate commerce in violation of the dormant Commerce Clause—starts by assuming that every state has the same tax structure as the state with the tax at issue. If that hypothetical scenario places interstate commerce at a disadvantage compared to intrastate commerce by imposing a risk of multiple taxation, then the tax fails the internal consistency test and is unconstitutional.
Although the Wynne decision does not address the validity of other taxes beyond the Maryland county personal income tax, the decision does create significant doubt as to the validity of certain other state and local taxes such as the New York State personal income tax in the way it defines “resident.” New York State imposes its income tax on residents on all of their income and on non-residents on their income earned in the state; this is similar to the Maryland county income tax at issue in Wynne.
“Resident” is defined as either a domiciliary of New York or a person who is not a domiciliary of New York but has a permanent place of abode in New York and spends more than 183 days in New York during the tax year. N.Y. Tax Law § 605. (New York City has a comparable definition of resident.) N.Y.C. Administrative Code § 11-1705. Thus a person may be taxed as a statutory resident solely because they maintain living quarters in the state and spend more than 183 days in the state, even if those days have absolutely nothing to do with the living quarters; this category of non-domiciliary resident is commonly referred to a “statutory resident.” As such, under New York’s tax scheme, a person can be a resident of two states—where domiciled and where a statutory resident—and thus be subject to taxation on all of their income in both states.
Although New York State grants a credit to residents for taxes paid to another jurisdiction, that credit is only for taxes paid “upon income derived” from those other jurisdictions. N.Y. Tax Law § 620. As such, New York State does not grant a credit for taxes paid to another jurisdiction on income earned from intangible property, such as stocks, because income earned from intangible property is not ‘derived from’ any specific jurisdiction.
To illustrate using an example, suppose an investment banker is unquestionably a domiciliary of New Jersey and has an apartment, i.e., permanent place of abode, in New York that he uses only occasionally. Further, suppose that the investment banker spends more than 183 days in New York during a tax year by going to his office in New York on most workdays. In such a case, the investment banker is a resident of both New Jersey and New York and subject to tax as a resident in both states on his entire worldwide income. New York does not give a credit for taxes paid to New Jersey on income derived from intangible property, and thus the investment banker pays tax on this income twice, once to New Jersey and once to New York, clearly disadvantaging interstate commerce and resulting in double taxation.
This is not some hypothetical example. This is actually the fact pattern in In the Matter of John Tamagni v. Tax Appeals Tribunal of the State of New York, 91 N.Y.2d 530 (1998). In that case, the New York Court of Appeals (New York State’s highest court) held that New York State’s taxing scheme did not violate the dormant Commerce Clause and did not fail the internal consistency test. The validity of the Court of Appeals’ decision is seriously called into question under the Wynne case.
The Court of Appeals, relying upon Goldberg v. Sweet, held that the dormant Commerce Clause did not apply to residency-based taxes because those taxes were not taxing commerce, but rather a person’s status as a resident. However, the U.S. Supreme Court’s decision in Wynne not only repudiates the very dicta from Goldberg v. Sweet cited by the New York Court of Appeals in Tamagni, but the U.S. Supreme Court also determined that even if a state has the power to impose tax on the full amount of a resident’s income, “the fact that a State has the jurisdictional power to impose a tax [under the Due Process clause of the Constitution] says nothing about whether that tax violates the Commerce Clause.” After Wynne, it is clear that the dormant Commerce Clause applies to residency-based personal income taxes.
The second reason that the vitality of the Tamagni decision is in question is its application of the internal consistency test. The Court of Appeals held that even if the dormant Commerce Clause applied, the internal consistency test was not violated because the tax at issue was imposed upon a purely local activity and thus could not violate the Complete Auto tests. However, as discussed above, New York State’s lack of a credit for taxes paid to other jurisdictions mirrors the lack of a credit under Maryland’s county income tax scheme.
New York State taxpayers should be cognizant of the Wynne decision and should consider filing refund claims if they have paid— or will pay—tax to New York State as a statutory resident (i.e., not as a New York domiciliary). One would expect the New York State Department of Taxation and Finance to be quite resistant to granting such refunds and likely to vigorously defend the existing taxing scheme.
It may be worthwhile to note that this problem of double taxation was acknowledged and addressed in an agreement executed in October 1996 by the heads of the revenue agencies of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Under that agreement, the “statutory resident” state would provide a credit for the taxes paid by the individual on his or her investment income to his/her state of domicile. Unfortunately, that agreement was never implemented through legislation— maybe now is the time for that to be done.
Finally, a word about New York City: New York City imposes a personal income tax on residents, allowing no credit for taxes paid to other jurisdictions. However, New York City does not impose a tax on non-residents, making its personal income tax different than the Maryland county income tax. Thus, the constitutionality of the New York City personal income tax is not specifically addressed by the U.S. Supreme Court’s decision. However, similar to the New York State definition of resident, a person can be a resident in two different jurisdictions under the New York City definition of resident. As such, New York City’s personal income tax could be imposed twice on a person if the person is a domiciliary of one state and a statutory resident in another. Thus, the tax potentially fails the internal consistency test.