Written by William Delaney, EA, ATA of Westwood, MA
Maryland has a somewhat unique income tax system in that it imposes a state income tax; a county income tax; and a special non-resident tax in lieu of the county tax. Both the income tax and the applicable county or special non-resident tax are collected on the one income tax form (MD Code, Sec. 10-101 et seq.)
The MD Code allows a credit against a taxpayer’s MD state tax liability for taxes paid to another state on the same income taxed by MD. However, the MD Code was amended in 1975 to uncouple the allowable credit from the county income tax portion of the state income tax. Thus, that credit cannot be taken against the portion of the MD income tax known as the county income tax.
Now comes Brian and Karen Whynne, taxpayer residents of Howard County, MD. Brian Whynne is a shareholder in an S corporation and reported K-1 pass-through income on his MD state income tax return. A substantial portion of that income was subject to tax in other states (the S corporation filed income tax returns in 39 states). The Wynne’s paid income tax on this income to the other states (these other taxing entities did not assess a county or similar type tax) and claimed credit for taxes paid on their MD return.
The MD state comptroller determined that the out-of-state credits should be limited to the income tax portion of their MD tax liability and no out-of-state credits should be apportioned to the county income tax liability. The Wynne’s did not dispute this determination, since it was consistent with the amended MD Code. The Wynne’s did, however, appeal based on an argument that this credit limitation violated the Commerce
Clause of the Federal Constitution and was discriminatory. The appeal amounted to a first-time action against the statutory language in the MD Code. The MD Tax Court rejected their argument.
The Wynne’s appealed to the Circuit Court for Howard County, which reversed the Tax Court and remanded the case back to that court for “an appropriate credit for out-of-state income taxes paid.” The state appealed to the Court of Special Appeals. Prior to a hearing, the Court of Appeals agreed to hear the case.
Critical to the appeals process was the issue of whether or not the county tax was an income tax for purposes of applicability of the federal Commerce Clause. The MD Court ruled that it was and found, further, “whether the tax is nominally a state or county tax is irrelevant for purposes of analysis under the dormant Commerce Clause because a state may not unreasonably burden interstate commerce through its subdivisions any more than it may at the state level. Associated Industries v. Lohman, 511 U.S. 641,
The Court noted that taxpayers with mostly in-state income are treated differently from taxpayers with mostly out-of-state income due to the limited application of an offsetting credit when out-of-state income is present. This taxation of out-of-state investments and business income at a higher rate was a violation of the federal Commerce Clause.
In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977) the United States Supreme Court enunciated a four prong test. Pass it and the state tax survives a challenge under the dormant Commerce Clause; fail any one prong and the state tax fails to pass challenge under the dormant Commerce Clause.
The parties agreed that the MD state tax passed challenge under the first two prongs, so the Court was left with analysis of prongs three and four:
(3) is not discriminatory towards interstate or foreign commerce; and
(4) is fairly related to the services provided by the State.
Quoting from the decision (regarding non-discrimination) “Internal consistency is thus measured by the answer to the following hypothetical question: If each state imposed a county tax without a credit in the context of a tax scheme identical to that of Maryland, would interstate commerce be disadvantaged compared to intrastate commerce?” The Court concludes that the answer would be yes because “taxpayers who earn income from activities undertaken outside of their home states would be systematically taxed
at higher rates relative to taxpayers who earn income entirely within their home state. Those higher rates would be the result of multiple states taxing the same income.”
Next, the Court considered external consistency “Does tax liability under the Maryland income tax code reasonably reflect how income is generated?” Due to the potential for multiple states taxing the same income (due to the absence of an offsetting credit or credits) the Court concluded that “the operation of the county tax appears to create external inconsistency.”
Finally, in a lengthy analysis, the Court concluded that “the application of the county tax to pass-through income sourced in other states that tax that income, without application of an appropriate credit, discriminates against interstate commerce.”
Having thus failed the tests under prongs 3 and 4, the Court arrived at its decision. “As for relief, the Wynnes suggest in their brief that the Maryland county income tax, the credit, or some part of the Maryland tax scheme be ‘struck down.’ In fact, the county income tax itself is not unconstitutional. Nor is the credit, which serves to ensure that the Maryland income tax scheme operates within constitutional constraints. Nor is the
Maryland income tax law generally. What is unconstitutional is the application---or lack thereof---of the credit to the county income tax...The county income tax was only eliminated from the computation and application of the credit by a 1975 amendment of the tax code...It is that amendment, when applied to the particular circumstances of taxpayers like the Wynnes, that contravenes the Constitution. On remand from the Circuit Court, the Tax Court should recalculate the Wynne’s tax liability in a manner consistent with this opinion.”
Now comes the Comptroller of the Treasury of Maryland to request that the United States Supreme Court take up the matter. The Supreme Court has agreed to do so. The United States Department of Justice has joined in the appeal by filing an amicus curiae (friend of the court) brief (April 2014). This brief, in support of the position of the state of MD, asserts some questionable, at best, theories (in my humble opinion).
The federal government asserts, without citing any authority, that there is a difference between the MD state income tax and the county income tax, a position which has been refuted by the Court of Appeals of Maryland which cited Associated Industries v. Lohman (see above), a use tax case with similarities to the MD county tax/special tax scheme.
The brief also asserts that “nothing in the Commerce Clause compels a State to offer such credits or otherwise defer to other States in the taxation of its own residents’ income.” Further, “If the Commerce Clause limited a State’s authority to tax the income of its own residents, as the Maryland Court of Appeals believed, then a longstanding and significant principle of this Court’s state-taxation jurisprudence would be a virtual dead letter.” Absent in this argument is any distinction between the income tax and the county tax, since the principles argued (no requirement to allow a credit; no restriction on the right to tax) are not limited to one or to the other. So, the practical effect of the federal government’s argument is that each state may tax and there is no lawful recourse for a taxpayer who may face multiple taxation on the same income.
The brief then goes on to question whether the Supreme Court’s four prong test (see Complete Auto Transit Inc. v. Brady cited above) even applies “to a State’s taxation of its own residents’ income.” In the event, however, that it does apply, the brief posits that the “county income tax satisfies that test, even if Maryland declines to credit out-of-state income taxes against the county tax”. It would be helpful to the Supreme Court if the brief embraced one argument and did not try to walk on both sides of the street at the same time. Of what use to that court is an argument which may be taken either way?
From my point of view, what appears to be at stake here is the survival of the “dormant Commerce Clause” which is essentially federal protection for taxpayers who are subject to tax by more than one state on the same income. Absent some form of protection, there is nothing to stop multiple taxation with no available offset so as to avoid double, triple, etc. tax levies. Our federal government is arguing the validity of such a tax scheme. We argue otherwise.
See Maryland State Comptroller of the Treasury v. Brian Wynne, et ux. No. 107,
September Term 2011, (1/28/13).