U.S. Supreme Court Sides With Taxpayer in Controversial Maryland Income Tax Case

In Comptroller of the Treasury of Maryland v. Wynne, a sharply divided, 5-4 decision, the U.S. Supreme Court held that Maryland’s personal income tax scheme, which prohibits resident individuals from offsetting county level income taxes by amounts paid to other jurisdictions, violates the federal dormant Commerce Clause.

In Maryland, personal income tax on state residents consists of a state income tax and a county income tax. Residents that paid income tax to another jurisdiction for income earned in that other jurisdiction my take a credit against the state tax, but not the county tax. Despite having different names, both components of the tax are ultimately state income taxes. As a result, income earned by Maryland residents outside the state is sometimes taxed twice, creating an additional burden on interstate economic activity.

The taxpayers, Brian and Karen Wynne, earned pass-through income from a Subchapter S corporation that earned income in 39 states. They received a credit against their Maryland state income tax for taxes paid to other states, but not their county income tax.

The Supreme Court found that Maryland’s tax scheme failed the “internal consistency” test, which examines whether income would be subject to double taxation if every state has the same tax structure. With respect to the county tax component, residents would be subject to double taxation on their out-of-state income, while income earned in Maryland would not be. If every state adopted Maryland’s tax scheme, interstate commerce would be taxed at a higher rate than intrastate commerce. Based upon the internal consistency test, the Court held Maryland’s income tax discriminated against interstate commerce in favor or intrastate commerce and, therefore, violated the dormant Commerce Clause.

This ruling is likely to affect thousands of other cities, counties, and states with similar tax laws, including New York, Indiana, and Pennsylvania. Ohio municipalities could also see fallout from the Wynne decision. Ohio’s complex municipal income tax laws may place Ohio cities at odds with the Supreme Court’s decision. Because each city establishes its own income tax laws, Ohio cities are not required to give credit for income tax paid to another city and often only provide for a partial credit. This lack of reciprocity causes double taxation on Ohioans, forcing them to pay municipal income tax to both their nonresident and resident cities. On a state level, Ohio’s state government will most likely not be affected by the Wynne decision because it provides full credit for taxes paid on income earned outside the state.

Maryland now owes about $200 million in refunds and interest to the Wynnes and other residents who claimed a credit on the county tax between 2006 and 2014. Going forward, this could cost Maryland an estimated $42 million a year in tax revenue. For questions related to the Wynne decision and how it may affect your reporting obligations, please contact Steve Dimengo, Richard Fry, or Casey Davis.

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