Wynne's effect on state and local personal income taxes.

• Author: Martin, Kevin

EXECUTIVE SUMMARY

* In Wynne, the Supreme Court held that Maryland's individual income tax scheme, which provided a partial credit for taxes paid to another jurisdiction, violated the dormant Commerce Clause by discriminating against interstate commerce.

* In its opinion, the Court found that while the Due Process Clause allowed states to tax out-of-state income of its residents, the state's tax system could nonetheless be invalid under the stricter requirements of the dormant Commerce Clause.

* Under Supreme Court dormant Commerce Clause precedent, a tax system must meet an internal consistency test and external consistency test to be valid.

* The Court found that the Maryland tax system did not meet the internal consistency test because if every state had the same system as Maryland, the tax on interstate commerce would be higher than the tax on intrastate commerce.

* Although the Court struck down Maryland's tax regime, it did not specify that states must use any particular method in their tax regimes to satisfy dormant Commerce Clause requirements.

* The Court did not draw any distinctions between state taxes and taxes below the state level, so that state, county, city, and other local taxes are treated the same as state taxes when considering whether a credit is valid.

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A recent U.S. Supreme Court decision could fundamentally alter personal income tax rules for taxpayers who file returns in multiple states. On its face, the decision in Maryland v. Wynne (1) (decided May 18, 2015) directly affects only Maryland taxpayers, but its rationale could extend to taxpayers in other states, including individuals who are denied a tax credit on their resident return for the local income and earnings taxes they paid to out-of-state jurisdictions.

This article explores the facts and arguments of the Wynne case, how this unique decision relates to and departs from case precedent, and--importantly--the intended and possibly unintended consequences of the Wynne decision on the taxing schemes of other states and localities across the country.

The Facts of the Wynne Case

The petitioners, Brian and Karen Wynne, are a married couple residing in Howard County, Md. During 2006, the Wynnes held stock in an S corporation (Maxim Healthcare Services) that filed tax returns in 39 states. As a result of the passthrough income the Wynnes received on Schedules K-l, they owed taxes to several of these states, in addition to the taxes they owed to Maryland as residents.

The Wynnes claimed a credit on their jointly filed Maryland resident return for income taxes they paid to other states. As most states do, Maryland offers a credit against its state income taxes for income taxes its residents pay to other states, to prevent double taxation on interstate income. But in Maryland, the credit operates in a somewhat peculiar fashion.

While Maryland allows a credit against its state income taxes, it also imposes a county income tax, and no credit is allowed against this tax for taxes paid to other states. (2) Residents pay the county tax at a rate specified by the county they reside in (not more than 3.2%). Nonresidents with income sourced to Maryland pay a "special nonresident tax" equal to the lowest county tax rate in effect at the time (1.25%). All of the revenue generated from the county tax is collected by the state but transferred directly to that county.

According to these rules, Maryland allowed only a partial credit to the Wynnes. They were allowed a full credit against their Maryland state income tax, but they were denied any credit against their Howard County tax. When Maryland disallowed the credit, the Wynnes were assessed a tax deficiency, which they challenged.

The Wynne Case's Legal Journey and Earlier Challenges to the Maryland law

Maryland courts had already addressed the Maryland credit for income taxes paid in previous state decisions.

An earlier version of the statute did not expressly limit the credit to the state portion of the tax liability. As a result, in Stern v. Comptroller, (3) the Maryland Court of Appeals allowed a credit for the county tax portion paid. After the Stern decision, the Maryland Legislature amended the statute, expressly limiting the credit to the state income tax portion. The Maryland Court of Appeals upheld this limitation in Comptroller v. Blanton. (4)

Maryland Tax Court

In the Wynnes' first court challenge to their tax deficiency, the Maryland Tax Court sided with the state, citing the amended language of the statute, as well as Blanton. (5) The state tax court asserted that, for the county tax portion of the tax bill, "You don't get the credit, and it's not unconstitutional to do this." (6) Presumably, the tax court believed the state was not constitutionally required to grant any credit against the county tax portion.

Maryland Circuit Court for Howard County

The Wynnes appealed to the Maryland Circuit Court for Howard County, which reversed the state tax court's decision, finding that the Maryland statute violated the "dormant" Commerce Clause of the U.S. Constitution. (7) The dormant Commerce Clause is a judicial doctrine inferred from the Commerce Clause (found in Article I, [section] 8, cl. 3) that expands on the explicit federal power in the Commerce Clause to regulate commerce among the states. The dormant Commerce Clause prohibits the states themselves from passing any laws that would unfairly restrict or inhibit interstate commerce. The circuit court emphasized that none of the prior Maryland decisions regarding this credit, including Blanton, explicitly addressed the dormant Commerce Clause.

One interesting argument Maryland raised in this court is that because the revenue generated from the county tax is paid only to counties and cities, the revenue cannot be viewed the same as the state portion of the income tax. In its decision, the court said that that distinction is not meaningful because the county taxes were not shown to be directly related to any services that the county or state had rendered to the Wynnes.

It is also worth noting that, in Frey v. Comptroller, (8) the Maryland Court of Appeals specified that the "special nonresident tax" paid by nonresidents as an equivalent of the county income tax was actually a state income tax. By extension, this holding would also likely mean that the "county tax" paid by residents is a state income tax. This view of the county tax as a state tax does not appear to have been challenged by the state at any level in the Wynnes' case.

Maryland Court of Appeals

Following the circuit court's holding in the Wynnes' favor, the Maryland Comptroller filed an appeal, and the Maryland Court of Appeals granted certiorari. The Court of Appeals affirmed the circuit court's decision and also found that the Maryland law violated the dormant Commerce Clause. (9)

This decision echoed many of the findings originally made by the circuit court. Here, the Court of Appeals briefly discussed the importance of the distinction between state and county taxes:

The Comptroller advances an alternative argument. Because an individual can only be a resident of one county in the universe, even if every taxing jurisdiction adopted Maryland's tax structure, the individual would only be required to pay a county tax once. This, argues the Comptroller, precludes the possibility of multiple taxation by operation of the county tax. However ... under dormant Commerce Clause analysis, there are generally only two levels of regulation, state and federal. See Associated Indus. v. Lohman, 511 U.S. 641, 650-51 (1994). The Comptroller's analysis posits a third level, the local level, such that a local tax need only be considered in the light of local taxes in other jurisdictions. But there appears to be no authority in the case law for this position. In other words, the dormant Commerce Clause does not differentiate between state and local taxes. This language suggests that even if the county tax in this case were truly a local tax collected by the county for which it is paid instead of the state, it would still violate the dormant Commerce Clause because a full credit is not available against that tax.

Two Court of Appeals judges dissented in this case. That dissenting opinion argued that the Wynnes had not shown that the county tax imposed on residents, as opposed to the special nonresident tax, had any effect on interstate commerce. Therefore, unlike in Frey, they argued that the dormant Commerce Clause did not apply.

Precedents Address Multistate Corporate Taxation

In addition to the prior Maryland cases discussing this particular statute, these lower court decisions brought up several earlier Supreme Court cases that dealt with similar situations involving multiple state taxation. However, all of these cases are distinguishable in one way or another, which is a large reason the Wynne...