The U.S. Supreme Court has announced it will hear the appeal in Comptroller v. Wynne, on whether states must provide a credit against its own taxes for taxes a resident pays to another state. Maryland allows such a credit against its state income tax but not against its local county and city income taxes.
The taxpayers in the case, Mr. and Mrs. Wynne, owned 2.4 percent of a company doing business in 39 states. Maryland residents, they paid $123,434 in income tax to Maryland, after applying a credit of $84,550 for taxes paid to other states on income earned outside Maryland’s borders. Maryland disallowed the credit to the extent that it offset the county income tax. The Tax Court upheld the assessment, a Maryland circuit court reversed and sided with the Wynnes, and Maryland’s highest court (the Court of Appeals) agreed, ruling the tax unconstitutional without a credit. The state has now appealed to the Supreme Court.
It’s hard to think of a more blatant example of impermissible state taxation of interstate commerce than Maryland’s tax here. Maryland certainly has the authority to tax the Wynnes — they are Maryland residents — but gets into constitutional trouble when it asserts the power to tax income earned outside Maryland.
Double-, Triple-, Quadruple- Taxation
Until this case, it has generally been undisputed by scholars that such a tax is only permissible if the state credits the taxpayer for taxes paid to another state. Otherwise, states would be able to subject the same income to double-, triple-, quadruple-, etc. levels of taxation. The net result of this would be to strongly discourage interstate investment and commerce of the type the Wynnes undertook, since only by investing within Maryland would income not be subject to gargartuan levels of taxation.
Analyzing whether Maryland’s tax is constitutional is a two-step process.
First, one must ask whether the state has the authority to impose the tax on income. This is fairly well-settled, with the statute authorizing the tax and numerous court precedents allowing states to tax their residents however they wish, with any credits or deductions a matter of legislative grace.
Second, though, one must ask whether the tax discriminates against interstate commerce. This has been sometimes described as an “internal consistency test” — if every state had such a tax, would the result be discrimination against interstate commerce? The answer here is unequivocally yes. The state (and the U.S. Solicitor General, who was asked for his views) performed step one of this analysis but did not do step two. Their arguments would get an F grade in any state taxation class as incomplete.
Possible Dangerous Outcome
Seventeen states have local income taxes, and while most provide a credit for taxes paid to another state, they probably do so because they think they have to, constitutionally. An adverse ruling here will quickly result in taxpayers being taxed on the state income over and over by any state with any tax authority over them. Although this case relates to local income taxes, there is no logical reason why the rule should be different for state income taxes.
It would have been best if the Court declined to hear the case and let the Maryland Court of Appeals ruling stand. As they have now agreed to hear it, the Court should take a strong stand against states using their tax systems to discriminate against interstate commerce. The Tax Foundation will make such an argument in our amicus brief. (Both the Maryland Attorney General and Wynne cited our 2011 local income tax study in their briefs to the Court.)
The case is No. 13-485, Comptroller of the Treasury of Maryland v. Brian Wynne, et ux.
Joseph Henchman ([email protected]) is vice president for legal and state projects at the Tax Foundation.