Maryland Personal Income Tax Ruled Discriminatory Against Interstate Commerce
Author: Rich Boer
On May 18, 2015, the U.S. Supreme Court ruled in Comptroller of the Treasury of Maryland v. Wynne et ux., upholding a Maryland Court of Appeals decision ruling that Maryland’s personal income tax scheme unconstitutionally discriminated against interstate commerce.
The court cited three dormant Commerce Clause cases—J.D. Adams Mfg. Co. v. Storen (1938), Gwin, White & Prince, Inc. v. Henneford (1939) and Central Greyhound Lines, Inc. v. Mealey (1948)—all of which invalidated state tax schemes that might lead to double taxation of out-of-state income and discriminated in favor of intrastate over interstate activity. The court held that, while Maryland had the jurisdictional power under the Due Process Clause to impose the tax, the tax scheme violated the Commerce Clause.
Maryland imposes a personal income tax on income earned by residents as well as nonresidents. For resident taxpayers, the tax comprises two parts: a state income tax imposed at a graduated rate and a county income tax imposed at a rate that varies by county. Nonresidents pay the state income tax on income earned from sources in Maryland and, if not subject to the county tax, a “special nonresident tax” in lieu of the county tax on income earned from sources in Maryland. The special nonresident tax is imposed at the lowest rate set by any Maryland county. To the extent a Maryland resident pays income tax in another jurisdiction on income earned in that jurisdiction, Maryland allows a credit against the state tax but not the county tax for the tax paid in the other jurisdiction.
In Wynne, the taxpayers were Maryland residents who earned pass-through income from an S corporation that earned income in several states. Taxpayers claimed a credit for income taxes paid to other states, but the Comptroller of Maryland only allowed a credit against the state income tax and not against the county tax. The comptroller’s decision was affirmed by the Hearings and Appeals section of the Comptroller’s Office and by the Maryland Tax Court.
However, the Circuit Court of Howard County reversed the decision on the grounds that Maryland’s tax system violated the federal Commerce Clause. The Court of Appeals of Maryland affirmed the circuit court decision, ruling the tax system unconstitutionally discriminated against interstate commerce. The appeals court evaluated Maryland’s tax scheme under the four-part test established in Complete Auto Transit, Inc. v. Brady. That case requires a tax applied to an activity with substantial nexus with the taxing state to be fairly apportioned, not discriminate against interstate commerce and be fairly related to the services provided by the state. In finding that Maryland’s tax system discriminated against interstate commerce, the appeals court held that the tax failed the fair apportionment and nondiscrimination parts of the Complete Auto Transit test. With respect to the fair apportionment test, the court held that the tax failed the “internal consistency” test—if every state adopted Maryland’s tax scheme, interstate commerce would be taxed at a higher rate than intrastate commerce. It also held that the tax failed the “external consistency” test by creating risk for multiple taxation. With respect to the nondiscrimination test, the appeals court held that the tax discriminated against interstate commerce because it denied residents a credit on income taxes paid to other states, which resulted in interstate income being taxed at a rate higher than intrastate income.
In upholding the appeals court decision in Wynne, the Supreme Court concluded Maryland’s personal income tax scheme violates the dormant Commerce Clause. The Commerce Clause of the U.S. Constitution grants Congress the power to regulate commerce “among the several states.” The dormant Commerce Clause (also called the “negative Commerce Clause”), while not expressly provided for in the U.S. Constitution, has been developed by federal court rulings. As the U.S. Supreme Court stated in Oklahoma Tax Commission v. Jefferson Lines, Inc., the Commerce Clause contains a further negative command—the dormant Commerce Clause—prohibiting a state from passing legislation that improperly discriminates against interstate commerce.
In this case, Maryland’s income tax scheme was deemed to have failed the “internal consistency” test for the same reasons as cited by the appeals court. The Supreme Court also noted that Maryland conceded its income tax scheme has the same effect as a state tariff, which the court cited as “the quintessential evil targeted by the dormant Commerce Clause.” In reaching its decision, the Supreme Court rejected the state’s argument that the three dormant Commerce Clause cases noted above should not apply because they involved a tax on gross receipts (rather than net income) and a tax on corporations (rather than individuals). The court noted its previous decisions have rejected the formal distinction between gross receipts and net income tax and that there’s no reason the dormant Commerce Clause should treat individuals less favorably than corporations. The court also was not swayed by the state’s contention that its tax was not discriminatory because it offered residents a credit against the state portion of the income tax, meaning Maryland actually receives less tax revenue from residents who earn income in interstate commerce than intrastate commerce. In rejecting this argument, the court said the critical point is that the total tax burden on interstate commerce is higher, regardless of whether the state receives more or less tax revenue from a particular taxpayer.
In addition to providing resident taxpayers in Maryland with a basis for filing refund claims for tax paid in other states against the county tax, the Supreme Court decision also provides resident taxpayers in other states and cities not currently allowing a credit for county and other local income taxes paid (such as Indiana, New York City, North Carolina, Ohio and Pennsylvania) a basis for filing refund claims to claim such credit.
If you have any questions regarding the Supreme Court’s decision and its impact, contact your BKD advisor.