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The U.S. Supreme Court has indicated interest in reviewing a Maryland Court of Appeals (the highest state court in Maryland) decision (Md. Comptroller of Treas. v. Wynne, 64 A.3d 453 (Md. 2013)) that the credit for taxes paid to other states must include the local tax in addition to the state portion of the tax. In addition, the U.S. Supreme Court has invited the Solicitor General to file a brief on this case expressing the views of the U.S. on this issue.


Maryland state and county tax


The State of Maryland assesses income tax on its state tax returns in two portions. The first portion includes the state tax at a maximum rate of 5.75 percent. The other portion includes the local county tax, which varies between 1.25 percent and 3.2 percent, depending on the tax rate imposed by the taxpayer’s county of residence. For nonresidents who pay Maryland state taxes, there is a special non-resident tax assessed instead of the county tax, which is equal to the rate of the lowest county tax. Since 1975, Maryland tax law has provided a credit to Maryland residents for taxes paid to other states only against the Maryland state portion of the tax and not against the county portion of the tax.


Factual background


Brian and Karen Wynne appealed a tax assessment that denied a tax credit against the Maryland county tax portion for tax payments made to other states. Mr. Wynne was a minority owner in an S-corporation, which filed state tax returns in 39 states. The S-corporation allocated to each shareholder a pro rata share of the taxes paid to the various states. Such tax returns did not indicate if payments of income taxes were made to any county or local entity in other states. The Wynnes appealed this double taxation.


Majority opinion of Maryland Court of Appeals


The majority opinion found that limiting the tax credit for payments of out-of-state income taxes to the state portion of the Maryland income tax was unconstitutional because it violated the dormant Commerce Clause of the U.S. Constitution by discriminating against interstate commerce. The Court stated that due to the denial of the tax credit, taxpayers who earn substantial income from out-of-state activities may pay significantly more in total state and local taxes than a similar taxpayer whose income is derived wholly from in-state activities. The Court determined that such different treatment creates a disincentive for the taxpayer (or his S-corporation) from engaging in income-generating activities in other states.


The majority opinion found the comptroller’s argument that the county income tax is not directed to interstate commerce unpersuasive and that the Wynnes have failed to identify any interstate commercial activity affected by the failure to allow for a tax credit against the county income tax. The majority opinion also found unpersuasive the comptroller’s alternative argument that if every taxing jurisdiction adopted Maryland’s tax regime, a taxpayer would only be required to pay one resident county income tax. The majority opinion seemed to indicate that they viewed the county income tax as a state tax for constitutional purposes. In addition, the majority opinion noted that under dormant Commerce Clause analysis, there are only two regimes, state and federal. The Court did not believe there was authority in case law to analyze a third level, a local tax level, so that such local taxes need to be only considered in light of local taxes in other jurisdictions.


Dissenting opinion of Maryland Court of Appeals


The dissent held that the Wynnes failed to meet their burden of proving that the dormant Commerce Clause was implicated because they failed to prove that requiring the payment of the county income tax without a tax credit either expressly discriminates against interstate commerce or places more than an incidental burden upon interstate commerce.


In addition, the dissent argued that the Wynnes benefit from the services provided by their county of residence that are funded with such county income taxes. The dissent argued that allowing taxpayers to pay a lesser amount of county income tax, would have the “possible absurd result” of having one neighbor pay little or no tax for county services while another neighbor with similar income may pay a substantial local tax to support such services.


Potential local tax impact


In the Maryland Attorney General’s brief to the U.S. Supreme Court, he noted that the Court of Appeals decision could cost local Maryland governments $45 million to $50 million annually. However, most counties and municipalities do not impose a local income tax and instead rely on sales taxes and property taxes to fund county and municipal services.


For those states that permit the imposition of local income taxes, the impact of a potential U.S. Supreme Court case requiring tax credits to be applied to local taxes could be huge, especially since not all local jurisdictions permit tax credits. For example, Ohio currently allows its municipalities to impose income taxes, which are usually imposed by the city in which a taxpayer works or generates pass-through income and the city in which the taxpayer resides. Generally, the city of residence will determine how much, if any, tax credit will be given for any taxes paid by such taxpayer in other local jurisdictions. This would generally apply if the local jurisdiction is within or outside the state. The current Ohio municipal tax regime may result in one neighbor paying local taxes in his city of residence to support local services, while another similarly situated neighbor pays no local resident taxes due to tax credits for payments made to other local jurisdictions. However, such services are also supported with property and sales taxes paid by taxpayers.


Interestingly, the majority opinion seems to view the county income tax as a state tax. If it is actually considered a state tax, then a tax credit should be granted against such county income tax for the payment of out-of-state taxes in order to avoid double taxation. However, if the county income tax is really a local income tax, then perhaps the Supreme Court will take the opportunity to analyze a third level, the local level, and what impact local income taxes may have on interstate commerce.