US Supreme Court issues Wynne ruling
Wynne wins, taxpayers win
TAX ALERT |
On May 18, 2015, the U.S. Supreme Court issued its opinion in Comptroller of the Treasury of Maryland v. Wynne, et ux, upholding the decision of the Maryland Court of Appeals that a Maryland resident owner of a flow-through entity may utilize his or her credit for income taxes paid to other states against both Maryland state-level and state-administered county-level personal income taxes.
Facts and procedural posture
Maryland, like many other states, imposes a personal income tax on the income its residents earn both within and outside the state, and provides a credit to its residents for income taxes paid to other states. However, Maryland's personal income tax is imposed under a two-tiered structure, with residents paying both a state-level tax and a state-administered county-level tax. Within this two-tiered structure, a resident can use his or her credit for income taxes paid to other states to offset only state level tax, and not the state-administered county-level tax. Accordingly, a Maryland resident taxpayer with a credit for income taxes paid to other states that exceeds his or her state-level tax gets no benefit from the excess credit to offset the county-level tax, and is, therefore, economically disadvantaged against a similarly situated taxpayer who only did business within Maryland.
Brian and Karen Wynne, the respondents in this case, are Maryland residents. In 2006, the year at issue, the Wynnes owned stock in Maxim Healthcare Services, Inc. (Maxim), an S corporation that had established nexus, filed income tax returns, and paid income taxes in 39 states on income passed through to the Wynnes. On their Maryland personal income tax return for 2006, the Wynnes claimed a credit for the state income taxes paid on their behalf by Maxim. However, the Wynnes did not follow Maryland's limitation on their use of this credit against the county-level tax, and, instead, utilized the credit to fully offset the state-level tax and utilized the excess credit amount against their county-level tax.
The Maryland State Comptroller of the Treasury (Comptroller), reviewed the Wynnes' 2006 personal income tax return, and issued an assessment against the Wynnes on the grounds that they were not entitled to use their credit for income taxes paid to other states against their county-level tax. The Wynnes filed an administrative appeal with the Hearings and Appeals Section of the Comptroller's Office, which adjusted the assessment amount but otherwise agreed with the Comptroller's conclusions. The Wynnes appealed to the Maryland Tax Court, which also affirmed the Comptroller's decision, and then to the Maryland Circuit Court for Howard County, which reversed on the ground that the limitation on the use of the credit for income taxes paid to other states against Maryland's state-administered county-level tax violated the Commerce Clause of the United States Constitution.
The Comptroller appealed the decision of the state circuit court to the Maryland Court of Appeals, the state's highest court, arguing that the state's county income tax is not directed at interstate commerce and that no interstate commercial activity was affected by a failure to allow a credit against that tax for income tax payments made to other states. The Maryland Court of Appeals disagreed, finding that the U.S. Supreme Court's decision in Complete Auto Transit, Inc. v. Brady controlled, and that the application of the county-level tax did not pass constitutional muster because the tax was not fairly apportioned and discriminated against interstate commerce.
With respect to fair apportionment, the Maryland Court of Appeals looked to the U.S. Supreme Court's internal and external consistency tests, and found that the county-level tax (1) failed the internal consistency test because interstate commerce would be taxed at a higher rate than intrastate commerce if every state adopted Maryland's tax scheme, and (2) failed the external consistency test because it created a risk of multiple taxation. With respect to nondiscrimination, the Maryland Court of Appeals found that the county-level tax discriminated against interstate commerce because the denial of the credit for income taxes paid to other states against the county-level tax resulted in a higher effective tax rate on interstate income than on intrastate income. Accordingly, the Maryland Court of Appeals upheld the decision of the Maryland Circuit Court for Howard County, and ruled that Maryland's two-tiered personal income tax structure was unconstitutional insofar as it denied the Wynnes a credit against the county-level tax for income taxes they paid to other states.
The Comptroller filed a petition for a writ of certiorari with the U.S. Supreme Court, which, after soliciting and receiving input from the U.S. Solicitor General, accepted the appeal. After receiving the briefs of the parties and a substantial number of amicus briefs, the Court heard oral arguments on Nov. 12, 2014, on the issue of whether the U.S. Constitution prohibits a state from taxing all the income of its residents by failing to provide a credit for taxes paid on income earned in other states. On May 18, 2015, the Court issued its five-Justice majority opinion affirming the ruling of the Maryland Court of Appeals, along with three dissenting opinions.
Opinion of the Court
Writing the opinion for the Court, Justice Alito, joined by Justices Kennedy, Breyer, Sotomayor, and Chief Justice Roberts, looked to the Court's Dormant Commerce Clause cases, including Northwestern States Portland Cement Co. v. Minnesota, which preclude a state from imposing "[…] a tax which discriminates against interstate commerce either by providing a direct commercial advantage to local business, or by subjecting interstate commerce to the burden of ‘multiple taxation'." The Court particularly relied upon its prior decisions in J. D. Adams Mfg. Co. v. Storen, Gwin, White & Prince, Inc. v. Henneford, and Central Greyhound Lines, Inc. v. Mealey, all of which were gross receipts tax cases decided in favor of the taxpayer because the taxes in question were unapportioned and resulted in a risk of multiple taxation merely because the taxpayers were engaged in an interstate business.
In relying upon these decisions to establish the applicability of the Commerce Clause to Maryland's personal income tax, the Court disregarded any distinctions between the gross receipts taxes considered and the personal net income tax at issue in the instant case, stating that for the purposes of constitutional review "we have now squarely rejected the argument that the Commerce Clause distinguishes between taxes on net and gross income." Additionally, the Court soundly dismissed the arguments of the Comptroller and the U.S. Solicitor General that the Commerce Clause protections applied to corporations should not apply to individuals because (1) "States should have a free hand to tax their residents' out-of-state income because States provide their residents with many services […]", and (2) individuals have the right to vote and can lobby against legislators who pass or fail to repeal tax measures. Lastly, addressing a concern of Justice Ginsburg in her dissent, the Court found that the "sovereign power [of a state] to tax the income of its residents, no matter where that income is earned" is a grant of power under the Due Process Clause of the U.S. Constitution, and is still subject to Commerce Clause limitations on the exercise of the power.
The Court then turned to the application of the internal consistency test, under which a court "looks to the structure of the tax at issue to see whether its identical application by every State in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate." To assist in this analysis, the Court provided the following simple example:
Assume that every State imposed the following taxes, which are similar to Maryland's "county" and "special nonresident" taxes: (1) a 1.25% tax on income that residents earn in State, (2) a 1.25% tax on income that residents earn in other jurisdictions, and (3) a 1.25% tax on income that nonresidents earn in State. Assume further that two taxpayers, April and Bob, both live in State A, but that April earns her income in State A whereas Bob earns his income in State B. In this circumstance, Bob will pay more income tax than April solely because he earns income interstate. Specifically, April will have to pay a 1.25% tax only once, to State A. But Bob will have to pay a 1.25% tax twice: once to State A, where he resides, and once to State B, where he earns the income.
Based on this example, the Court found that Maryland's tax structure imposed an unconstitutional burden upon interstate commerce, and postulated that it could be cured by either providing a credit to residents for taxes paid to other states or by removing the state tax on nonresidents. Accordingly, the Court determined that, since Maryland's tax structure failed to provide the requisite credit and imposed such a tax on nonresidents, it could not pass the internal consistency test and was an unconstitutional tariff.
Justice Scalia filed a dissenting opinion in which Justice Thomas joined in part. In his dissent, Justice Scalia argued that the Maryland tax structure was constitutional because the Dormant Commerce Clause on which the Court relied in formulating its opinion is nothing more than "a judicial fraud" and that the internal consistency test applied by the court is not in the "text or structure of the Constitution." Additionally, referring to the Dormant Commerce Clause dismissively as the "Synthetic Commerce Clause", Justice Scalia questioned whether addressing the negative implications of the Commerce Clause exceeds the limits of the judicial role, stating:
The [internal consistency] doctrine does not call upon us to perform a conventional judicial function, like interpreting a legal text, discerning a legal tradition, or even applying a stable body of precedents. It instead requires us to balance the needs of commerce against the needs of state governments. That is a task for legislators, not judges.
However, even with this heated challenge to the appropriateness of Dormant Commerce Clause analysis, Justice Scalia stated that stare decisis would require him to find a tax unconstitutional under the Dormant Commerce Clause "if (but only if) it discriminates on its face against interstate commerce or cannot be distinguished from a tax this Court has already held unconstitutional." Justice Thomas declined to join with this statement regarding judicial precedent.
Justice Thomas filed a dissenting opinion in which Justice Scalia joined in part. In his dissent, Justice Thomas argued that the Maryland tax structure was constitutional because the Dormant Commerce Clause on which the Court relied in stating its opinion "has no basis in the text of the Constitution, makes little sense, and has proved virtually unworkable in application, and, consequently, cannot serve as a basis for striking down a state statute." Additionally, Justice Thomas argued that the Court should have been guided by founding-era state income tax laws, which did not provide residents with a credit for taxes paid to other states and were not at that time considered to be unconstitutional.
Justice Ginsburg filed a dissenting opinion in which Justices Scalia and Kagan joined. In her dissent, Justice Ginsburg argued that there is an inherent flaw with empowering a state to tax all the income of a resident, regardless of where it is earned, under the Due Process Clause of the U.S. Constitution but limiting the exercise of that power under the Commerce Clause by requiring the state of residence to provide a credit for income taxes paid to other states. According to Justice Ginsburg this flaw can be summarized as follows:
[N]othing in the Constitution or in prior decisions of this Court dictates that one of two States, the domiciliary State or the source State, must recede simply because both have lawful tax regimes reaching the same income. […] True, Maryland elected to deny a credit for income taxes paid to other States in computing a resident's county tax liability. It is equally true, however, that the other States that taxed the Wynnes' income elected not to offer them a credit for their Maryland county income taxes. In this situation, the Constitution does not prefer one lawful basis for state taxation of a person's income over the other. Nor does it require one State, in this case Maryland, to limit its residence-based taxation, should the State also choose to exercise, to the full extent, its source-based authority.
Justice Ginsburg then proceeded to analyze a number of cases in which the Court determined that "a State may tax its residents' worldwide income, without restriction arising from the source-based taxes imposed by other States and regardless of whether the State also chooses to impose source-based taxes of its own." While Justice Ginsburg clearly supported the existence of the Dormant Commerce Clause, she would have had the court follow this line of reasoning to limit its application in the instant case, and upheld the Maryland tax structure.
The implications of this highly anticipated decision will likely take some time to fully play out.
At a high level, it is a positive sign that the U.S. Supreme Court has started to take up cases addressing the application of the Commerce Clause to state taxes, and came out strongly in favor of the continued applicability of Dormant Commerce Clause analysis. Additionally, it is interesting to see that the Court sees no distinction between individuals and corporations for Commerce Clause purposes, which bears consideration when analyzing the application of administrative rulings and judicial precedent. Lastly, the Court's clear statement that there is no distinction between gross receipts taxes and net income taxes for Commerce Clause purposes could arguably herald in significant change in the application of nexus principles, particularly in relation to Public Law 86-272, the right to apportion, throwback and throw out, and even the applicability of the Quill physical presence standard.
On the other side of the equation, it is uncertain how the states will seek to apply the Court's opinion that a state's tax on its residents would be constitutional if it provides a credit for income taxes paid to other states or refrains from taxing nonresidents on state-sourced income. If the states split, and some provide credits while others decline to tax nonresidents, there could be circumstances in which multistate individual taxpayers would be subject to constitutional multiple taxation.
In the near term, residents of Maryland and states with similar tax structures should consider filing refund claims in order to fully utilize credits for taxes paid to other states. Additionally, individual taxpayers should consider whether taxes for which they did not previously claim a credit are now creditable in their home state. Lastly, individual taxpayers should consider the application of the Wynne decision to local income taxes that are not state-administered but are substantially similar to the county-level tax imposed by Maryland.