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Multistate taxation: U.S. Supreme Court strikes down double-tax structure

June 1, 2015


In a highly anticipated decision, the U.S. Supreme Court recently addressed how Maryland taxes its residents’ out-of-state income. The decision in Comptroller of the State of Maryland v. Wynne, could ultimately have an impact in states such as Ohio, Kentucky, and Pennsylvania where state and local governments have similar “double-dipping” taxation structures.

The path to the Supreme Court

Maryland’s state personal income tax system has two components: (1) a state component whose tax goes directly to the state of Maryland; and, (2) a county component which flows to the taxpayer’s county of residence. Like other states, Maryland taxes its residents on all income, wherever derived. Maryland allows a credit for taxes paid to other states against the state component, but no similar credit is offered against the county component; the latter was deemed unconstitutional by the Court. Because Maryland did not allow a credit for the county portion of the tax, Maryland resident taxpayers are taxed twice on their income if such residents have income attributable to more than one state. If resident taxpayers only had income in Maryland, such income would be taxed once. This disparity causes double taxation and prohibited discrimination against interstate commerce.

Who Brought the Case?

The case originated from a 2006 Maryland resident personal income tax return filed by Brian and Karen Wynne, of Howard County, Maryland. The Wynnes reported $2.7 million of income; at least half of this income was derived from an S corporation that operated in several states. When the Wynnes tried to take a credit for $84,550 on their Maryland return for taxes paid to other states, they were allowed a credit for the state component of the tax but not for the county component. They appealed the Comptroller’s position and argued that Maryland was unfairly subjecting them to double taxation and taxing income that had no connection to the state of Maryland. The United States Supreme Court ultimately agreed with the Wynnes and found that Maryland’s tax scheme was unconstitutional.

The Court’s reasoning

On May 18, 2015, the Supreme Court affirmed the Maryland Court of Appeal’s ruling in favor of the taxpayers. In doing so, it found that Maryland’s failure to allow a credit against the county tax for taxes paid to other states violates the “dormant” Commerce Clause.

The Commerce Clause grants Congress the power to “regulate Commerce . . . among the several States.” The Supreme Court has long held that the clause’s language contains a feature known as the “dormant Commerce Clause,” which prohibits states from discriminating between transactions on the basis of some interstate element. In other words, a state can’t more heavily tax a transaction that crosses state lines than one that occurs entirely within the state, nor can it subject interstate commerce to “multiple taxation.”

Justice Samuel Alito, who wrote the majority opinion, concluded that, by taxing residents on all of their income without a credit for out-of-state taxes and taxing nonresidents on their income earned in the state, Maryland’s tax structure was inherently discriminatory. The structure, therefore, failed the “internal consistency” test and was invalid.

In their dissenting opinions, Justices Antonin Scalia and Clarence Thomas reiterated their previous arguments that the so-called dormant Commerce Clause doesn’t exist. They also dismissed Justice Alito’s use of the internal consistency test, which the two justices believe was dismantled by a prior decision.

Taxation of corporations vs. individuals

The Supreme Court also pointed out that it has long held that states can’t subject corporate income to higher taxes on dollars earned in interstate commerce. It found no reason not to provide similar protections to income earned by individuals, rejecting Maryland’s argument that individuals reap the benefits of local roads, police and fire protection, public schools and health benefits more than corporations do.

The Court observed that corporations use local roads to haul supplies and goods, call on local police and fire departments to protect their facilities, and rely on schools to educate prospective employees. Government services and the availability of good schools can aid businesses in attracting and retaining employees. Thus, the Court stated, “disparate treatment of corporate and personal income cannot be justified based on the state services enjoyed by these two groups of taxpayers.”

What Happens Next?

Maryland owes approximately $200 million in refunds and interest to the Wynnes and other Maryland residents who claimed a credit on the county tax between tax years 2006 and 2014. Prospectively, Maryland resident taxpayers who pay income taxes to other states on income derived outside of Maryland can claim a credit for such taxes paid on both the state and county portion of their Maryland tax return.

Far-reaching impact

What does this case mean for CSH clients and Ohio taxpayers? Wynne is an important tax decision because it seemingly protects income from being taxed more than once by states for entities operating as pass-through entities in multiple states. It also affirms the Supreme Court’s stance that a state tax system must pass tests under both the Due Process Clause and the Commerce Clause of the United States Constitution. The Court also failed to distinguish between traditional income taxes and gross receipts/hybrid tax schemes, stating all such tax regimes must be constitutional.

The Ohio School District Income Tax potentially falls within the Wynne decision as the School District income tax is analogous to the Maryland state/county tax system. As of January 2015, 189 Ohio school districts impose a school district income tax. The school district income tax is levied on either Ohio taxable income or earned income. These two amounts do not allow a credit for income tax paid in another state and thus result in double taxation for those taxpayers who are subject to the tax and have income from other states.

Additionally, Ohio municipalities could see cases arise from Wynne because many municipalities create their own tax credits for taxes paid elsewhere. Moreover, many Ohio cities take the position that a resident of their city who has partnership income or other income from a multistate pass-through entity is taxed on all income, regardless of where earned or derived. Some cities allow full credit for taxes paid to other jurisdictions, while certain cities do not. Therefore, the same risk of double taxation exists with cities that have taxation structures similar to those deemed unconstitutional by the Supreme Court in Wynne.

We will be monitoring developments from this important decision closely and will communicate with you any action steps that should be taken. Do not hesitate to contact your Clark Schaefer Hackett tax representative for any questions you have on this matter.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.


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