Supreme Court Decision May Affect State Taxes

In May 2015, the Supreme Court decided a case involving Maryland state personal income taxes (Comptroller of the Treasury of Maryland v. Wynne [No. 13-485]). The narrow 5-4 outcome in favor of the taxpayers, in which the Court held that Maryland’s personal income tax system violates the Constitution, could have far-reaching effects.

Maryland’s state personal income tax has two components: a “state” income tax, imposed at graduated rates, and a “county” income tax, imposed at a single rate depending on an individual’s county of residence. At the time of the dispute, Maryland offered a credit against the state tax for taxes paid to other states but not against the county tax.

Brian Wynne, a Maryland resident, was a part-owner of a health care company that operated nationally, filing income tax returns in 39 states. Because the company is an S corporation, its income flowed through to Brian and his wife, Karen, on their joint tax return. For the year in question, the Wynnes paid thousands of dollars in income tax to other states where the company operated. The Wynnes claimed a credit for the taxes paid to other states against their state and county income taxes. (A tax credit is a dollar-for-dollar reduction in tax owed.)

Maryland allowed the tax credit against the 5.75% state income tax but not against the county income tax. The couple challenged this determination administratively and in the courts, with the case eventually going to the Supreme Court, which held for the Wynnes. The Supreme Court held that Maryland’s personal income tax system was invalid because it led to some income being taxed twice, by Maryland and the state in which it was earned. This favored intrastate over interstate commerce, which the Court found violated the dormant Commerce Clause of the U.S. Constitution.

Gauging the impact
The decision will affect many Maryland taxpayers. According to some reports, about 8,000 residents have filed “protective refund” claims relating to this issue. Such claims preserve taxpayers’ rights in case of a favorable turn of events. Based on these numbers, $200 million of refunds could be triggered. This could help the individuals and companies that paid tax to other states but strain revenues in Maryland going forward.

The issue may reach beyond the borders of Maryland as well. Across the United States, many cities, counties, and other local entities tax residents’ income. If there are situations where business or individual taxpayers do not receive an offsetting tax credit, such laws might be invalid, in light of the Supreme Court decision.

Example: Bob Reynolds resides in a city with an income tax. Bob sells investment property in another state and incurs a taxable gain, thus requiring tax payments to the out of state jurisdiction as well as to his hometown. Unless Bob is entitled to an offsetting tax credit under his home state’s law, he may want to pay both the out-of-state and the local income tax and then file a refund claim, mentioning the Wynne decision.

Our office can help you determine whether any out-of-state income is being taxed twice, and help you to file a refund claim, if appropriate.

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