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U.S. Supreme Court strikes down income tax scheme as unconstitutional 

On Monday, the U.S. Supreme Court released its decision in Comptroller v. Wynne, in which it considered the constitutionality of Maryland’s personal income tax on state residents. Maryland’s law provides for both a state and county income tax, but when a resident earns income – and pays tax on that income – in another state, the law only allows for a credit against the resident’s state tax liability, not the county tax liability. The court concluded this double taxation scheme, in which income earned outside the state is taxed twice, first by the state in which it’s earned and then by Maryland, amounts to unlawful discrimination against interstate commerce.

Justice Alito wrote the 5-4 decision, and Chief Justice Roberts, and Justices Kennedy, Breyer and Sotomayor joined.

Background

Brian and Karen Wynne are Maryland residents. Brian owned stock in an out-of-state corporation, Maxim Healthcare Services, Inc., and earned income passed through from Maxim. They claimed a credit for the income tax they paid outside of Maryland, but the Maryland State Comptroller of the Treasury assessed a deficiency for their failure to pay county taxes. 

The Opinion

In its decision, the court relied on the dormant Commerce Clause, a “negative command” not contained in the language of the Commerce Clause. The Commerce Clause gives Congress the power to regulate commerce between the states, whereas the dormant Commerce Clause “prohibits certain state taxation even when Congress has failed to legislate on the subject.” 

The court justified its holding with references to well-established precedents that “all but dictate the result:” a state “may not tax a transaction or incident more heavily when it crosses state lines…” Similarly, a state may not impose a tax that advantages local businesses or that subjects interstate commerce to “the burden of multiple taxation.” The prior cases addressed corporate, rather than individual income, but the court did not view the distinction between corporate and individual taxes in this context as relevant. 

ScotusBlog noted that during the oral arguments, Justices Ginsberg and Kennedy seemed troubled by the result that could stem from a decision in the Wynnes’ favor, such that Maryland could receive nothing in tax from residents who benefit from their residency. Justice Ginsberg opined that this would leave the state “without a penny from this resident who may have five children that he sends to school in Maryland.” Justice Kennedy worried about the resident getting a free ride.

The court did not agree with the argument that individuals could be treated differently from corporations because individuals uniquely benefit from the provision of services, like schools, roads, police and fire protection, and health and welfare benefits. Instead, it reasoned that there was no basis to treat individuals and corporations differently because corporations “also benefit heavily from state and local services.” 

For example, trucks hauling a corporation’s supplies and goods, and vehicles transporting its employees, use local roads. Corporations call upon local police and fire departments to protect their facilities. Corporations rely on local schools to educate prospective employees, and the availability of good schools and other government services are features that may aid a corporation in attracting and retaining employees. Thus, disparate treatment of corporate and personal income cannot be justified based on the state services enjoyed by these two groups of taxpayers. 

Implications

The opinion doesn’t answer the question of how Maryland could solve the problem the court left it with. The court opined, “while Maryland could cure the problem with its current system by granting a credit for taxes paid to other states, we do not foreclose the possibility that it could comply with the Commerce Clause in some other way.” 

Maine Taxation Committee votes against eliminating income tax in the Pine Tree State

Earlier this year, Maine Gov. Paul LePage proposed a constitutional amendment by way of Legislative Document 1367, Resolution Proposing an Amendment to the Constitution of Maine to Eliminate the Income Tax. According to the preliminary fiscal impact statement, the resolution would have decreased the general fund revenue by $1.7 billion annually, and decreased local government fund revenue to municipalities by $90 million for any tax year beginning on or after Jan. 1, 2020. 

Last week, the governor’s office issued a press release lamenting the Taxation Committee’s vote against the resolution, which followed party lines.

Had the committee approved the resolution, voters would have seen the measure in a statewide referendum in November. Instead, they will have the chance to weigh in on the resolution only if two-thirds of the legislature supports it. In that event, the ballot question would be as follows: "Do you favor amending the Constitution of Maine to prohibit the Legislature, beginning Jan. 1, 2020, from enacting or imposing a tax on the income of any person and prohibiting the State from levying or collecting an income tax for any period beginning on or after Jan. 1, 2020?" 

The Portland Press Herald reported that Republicans supported the resolution because it “would spark business investment and lift Maine out of the economic doldrums.” On the other hand, Democrats claimed elimination of the income tax without any corresponding spending cuts, or additional revenue builders, is irresponsible, though politically popular. They observed, “It’s a giant amount of money….”

Republicans opined that the proposal is “worth the risk.”

Risky it is. A look at Kansas, a state that eliminated income tax for most businesses, may prove illustrative, even if not precisely analogous. In a recent Tax Foundation update on Kansas’ financial situation in the wake of its dramatic 2012 tax cuts, a policy analyst presented new fiscal estimates that “calculate a $422 million gap between revenues and expenses for the fiscal year beginning July 1, 2015, and a $600 million gap for the year after that. These estimates are upward revisions of earlier estimates by hundreds of millions…”  

The Tax Foundation has long argued that “[i]t is no secret that tax reductions, while producing positive economic benefits, would cost revenue and ultimately need to be paid for either by cutting spending or increasing taxes elsewhere.” 

The organization analyzed Gov. LePage’s tax reform proposal when it was proposed in January of this year. What is notable about his resolution is how much more drastic it is relative to the tax reform proposal, which recommended cutting, but not eliminating, the income tax, broadening the sales tax base, and raising rates. This, along with other provisions, would have improved the state’s standing in the State Business Tax Climate Index from number 33 to number 23.

Colorado: House passes anti-offshore tax haven bill, Senate promptly kills it

At the end of April, Colorado lawmakers passed House Bill 1346, which could have put a substantial dent in the use of off-shore tax shelters by Colorado corporations by way of a November 2015 ballot proposition. It would have asked voters to do the following:

  1. Increase the annual taxes of a corporation’s income that is sheltered in a foreign tax haven.
  2. Use the resulting tax revenue to help fund secondary public school education.
  3. Allow an estimate of the resulting tax revenue to be collected and spent notwithstanding any limitations in the Taxpayer’s Bill of Rights, which requires voter approval for tax increases and expenditures in order to “restrain most of the growth of government.”

According to the Denver Business Journal, sponsors were hoping to rein in certain firms that do not pay their fair share of taxes to the state. In particular, HB 1346 targeted those corporations that establish subsidiaries off-shore, in tax friendly countries, by requiring them to combine their off-shore and domestic incomes to determine the amount of taxes they owe to Colorado. The sponsors calculated that their legislation could raise up to $150 million for the state.

The Colorado Public Interest Research Group (CPIRG) was one supporter, having studied “the potential impact of corporate tax dodging on America’s small businesses.” On the basis of its study, the CPIRG justified HB 1346 because “the average Colorado small business owner would have to pay an extra $3,165 in taxes to make up for the money lost in 2014 due to offshore tax haven abuse by large multinational corporations.” More broadly, corporate tax avoidance costs Colorado an estimated $110 billion in state and federal income taxes, CPIRG argued. 

Even so, just a few days after the House passed HB 1346, the Colorado Capital Report, a publication of the Colorado Association of Commerce & Industry (CACI), revealed that the Senate State, Veterans and Military Affairs Committee voted it down. 

CACI offered the three major reasons for its opposition, declaring that HB 1346 would have:

  1. Dramatically changed the current tax reporting system under which businesses have operated for three decades. 
  2. Penalized legitimate Colorado businesses.
  3. Hurt Colorado’s ability to compete with other states when trying to attract foreign investment.
Further, CACI objected to the fact that HB 1346 would have changed a system that has been “working for a long time,” affected thousands of businesses adversely, and all without an “exhaustive stakeholder process.” The CACI saw HB 1346 as a “[h]ail Mary pass to find money for K-12 education.”

The Council on State Taxation (COST) is another group that opposed HB 1346. In a letter to the Colorado House of Representatives, COST opined that the legislation was an arbitrary application of “discriminatory treatment to corporations doing business in Colorado.”

Despite such vigorous and successful opposition, the CACI conceded that HB 1346 would likely be “introduced in the 2016 session as a continuing, broad-brush attempt by the anti-business, progressive House Democrats to force business pay its ‘fair share’ of taxes and to find more money for K-12 education.”

For additional information regarding these subjects, or any other multistate tax issues, please contact:

David M. Kall
216.348.5812
dkall@mcdonaldhopkins.com

David H. Godenswager, II
216.348.5444
dgodenswager@mcdonaldhopkins.com

Susan Millradt McGlone
216.430.2022
smcglone@mcdonaldhopkins.com

Multistate Tax Services

Businesses must be vigilant and careful in managing their state and local tax liabilities and exposures. We understand this can be a daunting task. McDonald Hopkins Multistate Tax Services provides a broad range of state and local tax services including tax controversy, tax evaluation, tax planning, and tax policy. With professionals who have worked both inside and outside government agencies, our multistate tax team leverages its knowledge and experience to help clients control their complex multistate taxes.

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