This week the US Supreme Court in Comptroller of the Treasury v. Wynne ruled in favor of the Wynnes -- Maryland residents and shareholders of a Subchapter S corporation -- by finding that Maryland’s taxation policy created the risk of double taxation and, therefore, violated the US Constitution by discriminating against interstate commerce.
Maryland, like many states and the federal government, taxes its residents on income regardless of the source state from which that income is earned. For taxpayers living in one state but deriving income from another state, this could lead to double taxation of the same dollar of income – once by the source state and once by the state of residence. Double taxation can be alleviated (to varying degrees due to different states’ tax rates) by allowing a credit for taxes paid to other states. Under existing laws in Maryland, a resident could credit taxes paid to another state to offset Maryland’s state tax, but not its county and Baltimore City income taxes, which are often referred to as “piggyback taxes.” The Wynnes challenged Maryland’s tax system and argued that the state’s failure to allow a credit (for out-of-state income taxes paid) against the piggyback taxes was unconstitutional.
In reviewing the Wynnes’ claim, the Court looked to what is commonly referred to as the Dormant Commerce Clause, and compared the consistency of treatment of intrastate taxpayers versus interstate taxpayers. Finding that Maryland’s tax system failed to treat such intrastate taxpayers and interstate taxpayers consistently, the Court ruled that the Wynnes could offset their Howard County, Maryland income tax with taxes paid to other states.
Within Maryland, the Court’s decision means that the state will be subject to refund claims by Maryland residents who were subjected to the double taxation; likely those residents with pass-through income from partnerships and S corporations subject to income tax in multiple states. Generally, a tax year will remain open (i.e., subject to refund claims as well as further tax assessments) for three years, but certain savvy taxpayers have been filing “protective” refund claims for more distant years in hopes of the outcome delivered by the Court in Wynne.
Outside of Maryland, the Wynne majority decision and particularly certain theories raised in the dissenting opinions regarding the relative taxing rights of the source state and residence state, could and likely will shape the way states “apportion” income among themselves going forward. States’ apportionment formulas (the methods by which states agree how to share tax revenue from interstate taxpayers) were historically crafted for manufacturing industries, giving preference to the states where production and sales took place. With the rise of internet commerce and service and information industries, states have increasingly looked to market-based formulas shifting tax revenue to the state in which the customer rather than the product- or service-provider sits.
The impact of the Wynne decision will undoubtedly bring some near-term smiles to certain Marylanders, but the impact upon and among all states remains to be seen, and will certainly be the topic of upcoming commentary.
If you have any questions regarding this Legal Alert, please contact Kevin P. Brandon, or another member of the firm's General Tax Group.
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