On May 18, the U.S. Supreme Court decided Comptroller v. Wynne, holding that Maryland’s personal income tax—which did not offer its residents a full credit for income taxes paid to other states on income they earned in those states—was unconstitutional.
The Court’s decision was deeply divided, with a 5-4 majority opinion by Justice Samuel Alito and dissenting opinions by Justices Antonin Scalia, Clarence Thomas, and Ruth Bader Ginsburg. The decision represents a significant victory for taxpayers and reaffirms the Court’s dormant Commerce Clause jurisprudence. TEI filed an amicus brief authored by Dan DeJong in support of the taxpayers, under the aegis of the State and Local Tax Committee, whose chair is Greg Potts.
The taxpayers in the case, Brian and Karen Wynne, were residents of Maryland who earned income from a subchapter S corporation that conducted business in many states. The S corporation’s income passed through to the Wynnes and was subject to tax on their personal income tax returns. Maryland imposed state-level and county-level taxes on its residents’ incomes, as well as a special state-level tax in lieu of the county-level tax on nonresidents’ incomes earned within the state. Maryland provided its residents with a credit for state taxes paid on income earned outside the state against the state-level tax but not the in-lieu-of-county-level tax. The Wynnes challenged Maryland’s tax scheme, claiming that it was unconstitutional.
The majority agreed and held that Maryland’s tax scheme violated the dormant Commerce Clause by discriminating against interstate commerce. The Court reaffirmed its prior jurisprudence, holding that the dormant Commerce Clause precludes a state from taxing a transaction more heavily when it crosses state lines than when it occurs entirely within the state.
Applying the internal consistency test, which hypothetically assumes that each state applies the at-issue tax scheme, the Court held that Maryland’s tax failed because Maryland residents earning out-of-state income would be taxed more heavily than Maryland residents solely earning in-state income. Specifically, Maryland residents earning out-of-state income would be subject to Maryland’s resident state- and county-level taxes, as well as a state-level and in-lieu-of tax on out-of-state income in the state where such income was earned, and they would only receive a credit for such taxes against its Maryland state-level tax. In contrast, a Maryland resident earning in-state income would be subject only to the Maryland resident state and county-level tax.
The Court’s application of the internal consistency test is relatively straightforward. Rather than challenge the application of this test, the dissenting justices focused on whether the test should be applied at all in the Wynnes’ case. Justices Scalia and Thomas each authored dissenting opinions claiming that the dormant Commerce Clause was a “judicial fraud” because it did not appear in the U.S. Constitution. Justice Ginsberg’s dissent, joined by Justices Scalia and Elena Kagan, took the position that the internal consistency test did not apply to a state’s taxation of its residents.
Justice Ginsberg reasoned that a state’s relationship with its actual, living residents is qualitatively different from the one it shares with other taxpayers (such as corporations and nonresidents) and that its relationship with its residents justified taxing one hundred percent of their income wherever earned. The majority opinion acknowledged that states may tax their residents’ incomes under the Due Process Clause, but it held that such taxes also must be consistent with Commerce Clause jurisprudence. The majority further held that there was no reason to treat personal income taxes differently than corporate income taxes.
Maryland’s taxation scheme is an outlier among states, as most states already provide their residents with a full credit for state taxes paid on income earned outside their borders. Maryland must now determine how it will remedy the discrimination found by the Court. Alternatives include providing residents with a credit against their county-level tax for taxes paid to other states on out-of-state income or repealing its special in-lieu-of tax imposed on nonresidents’ incomes earned within Maryland. The former is most likely, but the Maryland comptroller has not advised which course of action it will take.
Pilar Mata is state tax counsel at TEI