In Landmark Case, Supreme Court Finds Maryland's Tax Scheme Unconstitutional

[jklcpa]

Article in Forbes 5-18-15:  In Landmark Case, Supreme Court Finds Maryland's Tax Scheme Unconstitutional

Last May, Dominic Perella, argued that the way that the State of Maryland treated tax credits was wrong, arguing, “Maryland’s approach is unfair to people who make money in more than one state.”

As it turns out, the Supreme Court agrees, holding in Comptroller v. Wynne that Maryland’s tax scheme is unconstitutional because it doesn’t offer credit to its residents for taxes paid in other states.

This – as it applies both to state and local tax policy – is a big deal. To understand the case, we need to understand the context. How did this case find its way to the Supreme Court? Here are the details:

A married couple (the Wynnes) reported taxable net income of approximately $2.7 million to the State of Maryland. More than half of that amount represented a share of earnings in an S corporation with operations in several states. The Wynnes claimed a credit on their Maryland tax returns for taxes paid to 39 other states. The State of Maryland denied the credits and issued a notice of deficiency. The Wynnes appealed. At a hearing, the assessment was affirmed, meaning that the Wynnes were stuck paying the tax.

The Wynnes disagreed with the finding and amended their petition, claiming that the tax credit statute, as written, was in violation of the Commerce Clause of the United State Constitution. That claim was rejected.

So the Wynnes tried again, arguing this time that the State of Maryland was constitutionally required to extend the credit for taxes paid to other states to the county as well as the state. Their bigger question was whether a state had the unconditional right to tax all income based on residency (they, of course, said no). This time, the Circuit Court agreed with the Wynnes.

The State of Maryland appealed and lost with the Court of Appeals finding that the Constitution prohibits “double taxation” of income earned in interstate commerce. That means, the Court found, that a state may not simply tax all the income of its residents no matter where it is earned.

As you can imagine, the state of Maryland wasn’t thrilled with this finding. The state warned that this would result in a “significant loss of revenue that will amount to tens of millions of dollars annually.” So the state appealed. Again. Only there was one small problem. After Appellate Court, there’s really nowhere to go – except the Supreme Court.

The Supreme Court did not have “original jurisdiction” over this matter so the losing party (in this case, the State of Maryland) had the option of filing a petition to ask the Supreme Court to hear it. That’s what the State of Maryland did and the Supreme Court opted to hear it. That’s referred to as granted certiorari (or, for the cool, hipster kids who like to shorten their Latin, granted cert).

The case garnered a lot of attention. That’s because the case isn’t just about the Wynnes. Or Maryland. Even the State of Maryland acknowledged as much in its original petition, noting that the matter “has potential repercussions beyond Maryland.” The question of whether a jurisdiction – not just Maryland – can impose tax on its residents’ entire income even when that income may be subject to taxes elsewhere has nationwide implications.

The finding by the Supreme Court was, on its face, simply, “Maryland’s personal income tax scheme violates the dormant Commerce Clause.

The Court leaned heavily on the Commerce Clause, found at Art. I, § 8, cl. 3 of the Constitution, which gives Congress the right:

                "To regulate commerce with foreign nations, and among the several states, and with the Indian tribes;"

The Supreme Court noted that “we have consistently held this language to contain a further, negative command, known as the dormant Commerce Clause, prohibiting certain state taxation even when Congress has failed to legislate on the subject.” It sounds like a sleeping giant but what it means is that states may not pass laws that discriminate against or excessively burden interstate commerce.

The majority went on to distinguish between “(1) tax schemes that inherently discriminate against interstate commerce without regard to the tax policies of other States, and (2) tax schemes that create disparate incentives to engage in interstate commerce (and sometimes result in double taxation) only as a result of the interaction of two different but nondiscriminatory and internally consistent schemes.” The first, the Court found, is unconstitutional while the second is not.

The majority also noted that the discriminatory nature of Maryland’s tax structure “is not simply the result of its interaction with the taxing schemes of other States.” Rather, the court found that Maryland’s tax scheme is “inherently discriminatory and operates as a tariff.” Why does that matter? Remember Chief Justice Roberts’ commentary in the Health Care decision a few years back about a penalty versus a tax? Words matter. And the majority’s finding that the tax scheme is basically a tariff “is fatal because tariffs are “[t]he paradigmatic example of a law discriminating against interstate commerce.” (West Lynn, 512 U. S)  The Court, continuing to cite West Lynn, wrote, “tariffs against the products of other States are so patently unconstitutional that our cases reveal not a single attempt by any State to enact one.”

As to Maryland’s “but we tax everyone at the same rate so it can’t be discriminatory” argument? The Court wasn’t buying it, saying that “the fact that the tax might have ‘the advantage of appearing nondiscriminatory’ does not save it…”

In the end, it all came down to this: “the total tax burden on interstate commerce is higher” under Maryland’s current tax scheme. That double taxation scheme, the Court found, is unconstitutional.

Justice Alito delivered the opinion, joined by Chief Justice Roberts, and Justices Kennedy, Breyer and Sotomayor.

There were dissents. Lots of dissents. You have to read the dissents. It’s like reading the minority reviews on Amazon.com – generally not going to change your mind but they do offer perspective and they’re often entertaining – as is the case here.

Justice Scalia filed a dissenting opinion, which Justice Thomas joined in part. In the dissent, Justice Scalia refers to the notion of the dormant Commerce Clause as “judicial fraud” – but he’s in the minority here. He further reacts to the Court’s claims that the dormant Commerce Clause doctrine “has deep roots” by arguing, “So it does, like many weeds.”

Justice Thomas also filed a dissenting opinion, which Justice Scalia joined in part. Justice Thomas likewise didn’t embrace the notion of the Commerce Clause but the majority found his argument “plainly unsound.”

And in the most odd bedfellows dissent of all, Justice Ginsberg filed a dissent, joined by Justices Scalia and Kagan. Justice Ginsberg quotes a prior finding from the Court that “It is not a purpose of the Commerce Clause to protect state residents from their own state taxes.”

A great deal of the dissents focuses on the “people versus corporations” debate that we’ve seen before… definitely interesting party conversation. The opinion knocks parts of these dissents in a rather feisty manner.

You can read the opinion together with the dissenting opinions here (downloads as a pdf).

 

[jklcpa]

A related article about the ruling. http://www.cecildaily.com/news/local_news/article_f744867d-37f5-52d0-9c74-30a5bc5240a0.html

Posted: Wednesday, May 20, 2015 11:11 am

By Jane Bellmyer [email protected]

ELKTON — Cecil County residents who work in Delaware may be in for a tax refund thanks to a recent U.S. Supreme Court ruling.

The nation's highest court voted 5-4 that Maryland was — in effect — double taxing residents of the state for working in another. In "Maryland State Comptroller of the Treasury v. Brian Wynne," the judges opined that there was a breach of the Constitution when the state denied tax breaks to residents who worked out of state between 2006 and 2014.

"By mere virtue of our location, we were well aware of the outcome in Cecil County," said Craig Whiteford, budget manager for Cecil County. "We've been predicting an adverse capture."

That means the county expected to have to repay some of the money collected through the piggyback tax. It's money collected through the income tax filing process, assessing a percentage of the Maryland taxes due and disbursing it to the county of residence. For Cecil County, that rate is 0.028 percent.

"We had assigned some fund balance in anticipation of the impact," Whiteford said. "We were prepared for it."

The set aside total was $3.5 million. The court ordered that $1.3 million be returned each year for three years.

"We were not too far off," Whiteford said of the nearly $5 million punch.

The case centered on a Maryland couple with a medical business from which they filed taxes in 34 states.

"They got credit for the taxes paid to other states," Whiteford said.

However, there was no such rebate for the piggyback taxes paid to Howard County, the county of residence for the couple, Brian and Karen Wynne.

According to the Maryland Comptroller's Office, taxpayers in those affected years need to file an amended return to get any refund. It's estimated as many as 10,000 Cecil County taxpayers earn their income in Delaware, Pennsylvania or New Jersey.

While Cecil County was not the hardest hit — that was Montgomery County — those most affected here were individuals. Montgomery County had a higher number of businesses impacted, according to the comptroller's office.

 

[jklcpa]

Another article that explains it a little better. Basically, it's the piggyback add-on by the counties that is the problem.

http://www.washingtonpost.com/local/md-politics/supreme-court-rules-maryland-income-tax-law-is-unconstitutional/2015/05/18/1e92ee7a-d16f-11e4-ab77-9646eea6a4c7_story.html

 

[JJStephens]

Too bad they don't apply the same logic to the same income being taxed by the feds, state, school district and municipality. Deep sigh.

[Abby Normal]

Another article that explains it a little better. Basically, it's the piggyback add-on by the counties that is the problem.

http://www.washingtonpost.com/local/md-politics/supreme-court-rules-maryland-income-tax-law-is-unconstitutional/2015/05/18/1e92ee7a-d16f-11e4-ab77-9646eea6a4c7_story.html

 

​Yes, in many cases, little or nothing will change. I look at one yesterday and it saves about $300/year, but another lower income client was already getting 100% credit.

I can't find any older MD forms but I swear the credit used to be against both state & county taxes, then they changed it about 25 years ago so the county tax would show more prominently on the return.

[jklcpa]

JMDavis, I thought I remembered it that way too.

I want to make sure that I understand this correctly. So the way I understand this is that if the client already claimed 100% of the taxes paid to other states, there is nothing to amend for, correct?

 

[Abby Normal]

JMDavis, I thought I remembered it that way too.

I want to make sure that I understand this correctly. So the way I understand this is that if the client already claimed 100% of the taxes paid to other states, there is nothing to amend for, correct?

 

​Correct!

[jklcpa]

Thank you!

 

[Richcpaman]

Joe:

It hasn't been 25 years since they changed it. They have never allowed a tax credit for the local taxes. They changed it 12-15 years ago.  It used to just be a calculation, if the state tax was $1000, and the "piggy-back" tax was 50% of the state, then you added $500 to the taxes for the locality, and your total tax was $1,500.

Then they decoupled the "local piggy-back" tax from all the same deductions/exemptions.  So the math changed.  Actually the local tax went UP from this change, and the state taxable income could be lower than the local tax.  Following the example above, the state would get $1,000, and maybe the local tax could be $505 or $520.

However, this whole case is centered on the piggy-back tax and why the taxpayers could not get the tax credit on the local tax.  So, if they paid another state $2,000 in income tax on the same income, why did they only get to claim the credit against the $1,000, and not the $1,520? 

The Wynnes blew that all apart.  The Comptrollers office is still spinning.

According to the MACPA, (MD Assoc of CPA's) the Comptrollers office advised them that the Comptrollers will process refunds for MD taxpayers who are affected by this ruling.  Fat Chance.

Technically, you get to amend your clients returns back to 2006, when the case was originally filed, or when the Howard County Circuit Court Sided with the taxpayers in 2008/09.  So that $300 can become $1,200 to $1,800 pretty easy.  I have not been able to find out how far back we can amend.  I can see the Comptroller office's stating that the "three year" rule might apply.  It doesn't.  The filing of the court case should have tolled the statute.   

Lets do lunch.

Rich

 

 

 

 

 

 

 

 

[jklcpa]

Thank you, Rich.  I, too, remember that local tax being the 50% of the state.

Somehow it has worked out that none of my clients' returns will be affected. Those that were MD residents either worked in PA and had no PA tax because of the reciprocal agreement MD has with PA, or they worked in DE and were already allowed 100% of the DE tax liability on their MD returns. 

When you have an update to this, if you'd be kind enough to post the information, I'd really appreciate it.

[Richcpaman]

JKL:

You get to amend those MD Residents with DE income returns...  The way MD set up the tax credit, if your client paid $1,000 to DE, you might have got $950 on the MD return as a credit.  But, you should have gotten $1,000....  Because MD would only allow for the state side, not the local, thereby limiting the higher end of the credit.

I am looking for more info, so that I can amend the right way... 

Rich

 

 

[jklcpa]

Yes, I understand. I've already checked and my clients were allowed 100% of the DE tax liability as a credit on the original returns. There's nothing more for them to recover even if including the MD local in the calcs.

[Abby Normal]

    I am looking for more info, so that I can amend the right way... 

Rich

 

 

​I emailed a contact at the Comptroller's office and they are preparing a response. Problem is, 2011 returns can only be amended if they were filed on extension so the clock is ticking.

And you're right about the credit not being allowed against county tax ever. I just never noticed how the calculation worked until they broke the county out as a separate calculation.

[jklcpa]

Information on claiming the refund just came out over the weekend. There's a FAQ question page on Comptroller of MD website. There's a link on that page to the Wynne Decision Information that goes to this pdf.

Amended returns on Form 502X are to be filed for the prior years and 2014 returns already filed. MD will not be recalculation and correcting this automatically.  Preparers will be waiting for the software updates to forms and revised calculations of the credit.

For 2014 returns have not yet been filed, MD is developing a supplemental form that must be used and that is scheduled for release no later than 6/30/15, so again, preparers will be waiting for this form's release in the software.

This decision affects other states as well, and the Supreme Court left it up to the states to fix it. .