One of the issues that taxpayers face is accurately reporting their state income to the appropriate state taxing authorities and paying the correct amount of tax. But many taxpayers have income from multiple states—consider, for example, those who live in Connecticut or New Jersey and work in New York State, or those who own businesses with locations in several states. In addition, many taxpayers face state and county income taxes, depending on the form of local government. With many states looking for additional revenue, the question becomes: Could two states tax the same income—even when the taxpayer is a nonresident of the second state?
On May 18, 2015, the U.S. Supreme Court answered this question in Comptroller of the Treasury of Maryland v. Wynne et ux[575 U. S. __ (2015)], ruling in a 5-to-4 decision that two states cannot tax the same income.
Background
The taxpayer, Brian Wynne, a resident of Maryland, owned stock in Maxim Healthcare Services, Inc., a Subchapter S corporation. That year, Maxim earned income in states other than Maryland, and it filed state income tax returns in 39 states. Maxim’s earned income passed through to Wynne. On their 2006 Maryland joint tax return, Brian Wynne and his wife claimed a credit for income taxes paid to other states (resident credit) against both the state income tax and the county income tax.
Maryland, like most states, imposes a personal income tax on all income of its residents and on Maryland-source income for nonresidents that is composed of two parts:
- A state income tax based on a graduated rate [Md. Tax-Gen. Code Ann. section 10-105(a), Supp. 2014]; and
- A county income tax that varies from county to county, but is capped at 3.2% (Md. Tax-Gen. Code Ann. sections 10-103, 10-106, 2010).
Maryland’s personal income tax on nonresidents is also composed of two parts:
- A state income tax based on a graduated rate on all Maryland source income [Md. Tax-Gen. Code Ann. section 10-105(d), Supp. 2014]; and
- A special nonresident tax in lieu of the county tax at a rate equal to the lowest rate set by any Maryland county, because nonresidents are not subject to the county tax (Md. Tax-Gen. Code Ann. section 10-106.1).
As is the case with states that impose a personal income tax, Maryland does not tax nonresidents on any income that is not from Maryland sources (Md. Tax-Gen. Code Ann. section 10-106.1).
The Maryland State Comptroller of the Treasury denied the Wynnes’ credit with regard to the county income tax, but allowed the credit with regard to the state tax and assessed a tax deficiency. The Wynnes appealed this deficiency to the Hearings and Appeals Section of the Comptroller’s Office, which upheld the deficiency, with a slight modification.
Maryland State Court Appeals
The taxpayers then appealed to the Maryland Tax Court, which also affirmed the deficiency. However, on appeal, the Circuit Court for Howard County reversed the prior decision’s holding as violating the U.S. Constitution’s dormant Commerce Clause that grants Congress power to “regulate Commerce … among the several States” (Art. I, section 8, cl. 3). The Court of Appeals of Maryland affirmed the circuit court’s decision, citing Complete Auto Transit, Inc. v. Brady [430 U. S. 274 (1977)], which set forth the principle that, in order for a tax to comply with the dormant Commerce Clause, the tax must pass Complete Auto Transit’s four-part test:
- Is the tax applied to an activity with a substantial nexus with the taxing state?
- Is the tax fairly apportioned?
- Does the tax not discriminate against interstate commerce?
- Is it fairly related to the services provided by the state?
After evaluating the Wynnes’ case under Complete Auto’s four-part test, the appeals court held that the tax failed both the fair apportionment and nondiscrimi-nation portions of the Complete Auto test. In its decision, the court stated that “with respect to fair apportionment, the Appeals Court held that the tax failed the ‘internal consistency’ test because if every state adopted Maryland’s tax scheme, interstate commerce would be taxed at a higher rate than intrastate commerce and that the tax also failed the ‘external consistency’ test because it created a risk of multiple taxation.” With respect to nondiscrimination, the appeals court held that the tax discriminated against interstate commerce because it denied residents a credit on income taxes paid to other states and so taxed income earned interstate at a rate higher than income earned intrastate. Based on this analysis, the appeals court concluded that Maryland’s tax scheme was “unconstitutional insofar as it denied the Wynnes a credit against the ‘county’ tax for income taxes they paid to other States.”
Dormant Commerce Clause Controls
Justice Samuel Alito, writing the majority opinion, upheld the decision of the appeals court and stated, citing Boston Stock Exchange, “Under our precedents, the dormant Commerce Clause precludes States from discriminating between transactions on the basis of some interstate element” [Boston Stock Exchange v. State Tax Comm’n, 429 U. S. 318, 332, n. 12 (1977)].
Justice Alito also cited Central Greyhound Lines, Inc., in which New York sought to tax gross receipts that were derived from services provided in neighboring states [Central Greyhound Lines, Inc. v. Mealey, 334 U. S. 653 (1948)]. In its decision, the Supreme Court held “that the New York scheme violated the dormant Commerce Clause because it imposed an ‘unfair burden’ on interstate commerce.”
Based on these and prior cases, the Court affirmed the judgment of the Court of Appeals of Maryland that the state’s taxing scheme violates the dormant Commerce Clause because it is inherently discriminatory, operating as an impermissible tariff against residents who earn income in interstate commerce.
As a result of the decision, Maryland will process claims for refunds based on Wynne. All claims for refunds as a result of the ruling in Wynne for periods prior to tax year 2014 must be submitted in the form of an amended income tax return using Maryland Tax Form 502X. If a tax year 2014 return has already been submitted to the Comptroller’s Office, Form 502LC (State and Local Tax Credit for Income Taxes Paid to Other States and Localities) must be used; if a tax year 2014 return has not yet been filed, Form 502X must be completed, along with Form 502LC. Maryland will consider refund claims for all open years; thus, amended returns must be filed within three years from the time a return was filed or two years from the time the tax was paid, whichever is later. Properly filed protective claims that had been filed with the Comptroller’s Office pending the outcome of the litigation will also be processed.
Wynne Applies to All States
The Supreme Court’s decision in Wynne affects not only Maryland; it also has ramifications for all states that limit the amount of the resident credit for taxes paid to other states.
Although Wynne invalidates only Maryland’s refusal to grant credit for taxes paid to other states, it raises a question: Are the other limitations that states place on the computation of their resident credit similarly invalid?
Many states limit the resident credit to a percentage computed by dividing the income taxed in the other state by the income that would be taxed as if the taxpayer were a resident, times the tax that would be due if the taxpayer were a resident. This could cause taxpayer residents in a state with a low tax rate to be put at a disadvantage if they have income that is taxable in a state with a higher tax rate.
What Does Wynne Mean for New York?
As for New York, the question is: How does Wynne affect the resident credit of a New York City resident taxpayer that has income taxable in other states? Will Wynne apply? Will the resident credit be limited to the New York State tax or will it apply to the New York City tax as well? With regard to the New York City unincorporated business tax, will taxpayers in states other than New York (New Jersey, Connecticut, and Massachusetts, for example) have to give their resident taxpayers credit for any New York City unincorpo-rated business tax paid?
Based on conversations with high-ranking officials of the New York City Department of Finance, it is their opinion that the Wynne decision will not affect New York City. This opinion is based on the fact that New York City does not tax nonresidents, as opposed to Maryland, which does.
In the meantime, preparers should evaluate all taxpayers that might be affected by Wynne and decide whether filing protective claims is appropriate. q
