May 18, 2015

Supreme Court decides Comptroller of the Treasury of Maryland v. Wynne

On May 18, 2015, the U.S. Supreme Court decided Comptroller of the Treasury of Maryland v. Wynne, (No. 13-485), holding that Maryland’s personal-income-tax scheme, which does not give state residents a full credit for income taxes that they pay to other states, violates the Commerce Clause because it causes some of the income earned by Maryland residents outside the state to be taxed twice, thus creating an incentive for Maryland taxpayers to opt for intrastate rather than interstate economic activity.

Many people earn income in more than one state. The taxpayer’s state of residence is entitled under the Due Process Clause to tax income regardless of where it is earned, but the state where the income is earned also has the right to tax it. This creates the potential for double taxation.  Most states alleviate this problem by providing a full credit to their residents for income taxes paid to other states where the income is earned.

Maryland does things differently. It imposes both a “state” income tax and a “county” income tax on all income earned by its residents (despite the different names the state collects both taxes). If a resident earns some of his or her income in another state and pays income tax to the state in which the income was earned, Maryland gives the resident a credit against the “state” tax, but not against the “county” tax. Thus, some of the income that a Maryland resident earns outside the state may be taxed twice.

Brian and Karen Wynne (through their subchapter S corporation, whose income passed through to them as its shareholders) earned income in Maryland and other states. They paid income tax to the other states, and claimed a credit against their Maryland income tax for the total amount of tax that they paid to other states. The state denied a credit for the “county” portion of their taxes, and assessed a deficiency. The Maryland Tax Court upheld the assessment, but the state trial court reversed that assessment on the ground that Maryland’s personal income-tax system violated the Commerce Clause.  The Court of Appeals of Maryland (the state’s highest court) affirmed that decision.

The U.S. Supreme Court affirmed, holding that Maryland’s tax scheme violates the dormant Commerce Clause, which prevents states from taxing an interstate transaction more heavily than it taxes a transaction that occurs entirely within the state. The Court cited three of its past cases for the general proposition that the Commerce Clause prevents states from imposing double taxation of income earned outside of the state, and applied that general rule to this case in concluding that Maryland’s tax scheme imposed double taxation on some income that Maryland residents earned outside the state. The Court observed that such a tax scheme “creates an incentive for taxpayers to opt for intrastate rather than interstate economic activity,” and therefore discriminates against interstate transactions.

The Court rejected arguments that its prior cases dealt with taxes on gross receipts, rather than a tax on net income like the one at issue here, and that the two should be treated differently under the Commerce Clause. The Court pointed out that its cases long ago rejected a formal distinction between the two, and that its earlier decisions in this area were driven by the threat of double taxation, not the difference between the types of taxes imposed. The Court also rejected the argument that individuals and corporations should be treated differently under the Commerce Clause, with states being free to tax individuals less favorably than corporations because they enjoy more governmental services and can vote to change a discriminatory tax law. The Court observed that corporations also benefit from governmental services, and that the fact that someone can vote to change an unconstitutional law does not save the law from invalidity. The Court also rejected the claim that the dormant Commerce Clause could not “constrain” Maryland’s sovereign power to tax its residents, explaining that while the Due Process Clause may allow a state to tax all of the income that its residents earn (including income earned outside the state), the Commerce Clause is a separate brake on what a state may do in taxing its residents.  Finally, Maryland’s tax system failed the so-called “internal-consistency test” that the Court has applied under the dormant Commerce Clause. The Court left open the possibility that Maryland could, in the future, cure the problem in some way other than by allowing a full credit for taxes paid to another state. 

Justice Alito delivered the opinion of the Court, in which Chief Justice Roberts and Justices Kennedy, Breyer and Sotomayor joined. Justice Scalia filed a dissenting opinion, in which Justice Thomas joined in part. Justice Thomas filed a dissenting opinion, in which Justice Scalia joined in part. Justice Ginsburg filed a dissenting opinion in which Justices Scalia and Kagan joined.

Download Opinion of the Court.

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