A divided U.S. Supreme Court on Monday struck down as unconstitutional a Maryland law that bars Marylanders from deducting from city or county taxes any income tax they paid to other states on money earned there.
In its 5-4 decision, the high court upheld a 2013 Maryland high court ruling that the law violates the federal Constitution’s Commerce Clause by discouraging Marylanders from earning money outside the state.
The Supreme Court’s decision to uphold the Court of Appeals’ ruling could cost the state’s local governments between $40 million and $50 million annually, the Maryland Association of Counties stated Monday. MACO added that about $200 million in tax refunds might be owed.
“Our counties have been bracing for this for quite a while and trying to determine the best way to deal with the fiscal consequences,” MACO spokeswoman Andrea Mansfield stated in an email message. “We now have closure, but the decision is disappointing.”
About 55,000 Maryland taxpayers are affected by the decision and more than 8,000 refund claims based on the double taxation are pending and under review, according to the the Maryland comptroller’s office.
“The Supreme Court has made its determination,” the comptroller’s office said in a statement. “The Comptroller’s office will work diligently and in an timely manner to comply with the decision and enforce Maryland law consistent with the decision of the Supreme Court. ”
Attorney Neal Katyal, who represented Brian and Karen Wynne, the Howard County couple who challenged the taxation, said “the decision will provide an enhancement for Maryland residents who desire to work or operate in interstate commerce. It’s just and fair that the court ruled the way it did.”
Katyal is with Hogan Lovells US LLP in Washington, D.C.
The Supreme Court, by the slimmest of majorities, said the state’s ban on deducting tax on income earned out of state restrains interstate commerce. Under the Constitution, such regulation of interstate commerce is the province of Congress, not state legislatures, the high court added.
“Like many other states, Maryland taxes the income its residents earn both within and outside the state, as well as the income that nonresidents earn from sources within Maryland,” Judge Samuel A. Alito Jr. wrote in the court’s majority opinion.
“But unlike most other states, Maryland does not offer its resident a full credit against the income taxes that they pay to other states,” Alito added. “The effect of this scheme is that some of the income earned by Maryland residents outside the state is taxed twice. Maryland’s scheme creates an incentive for taxpayers to opt for intrastate rather than interstate economic activity.”
The Maryland attorney general’s office challenged the Court of Appeals’ ruling unsuccessfully, arguing that states have broad constitutional authority to “tax all income of its residents, even income earned outside the taxing jurisdiction.”
The high court’s decision also marks a defeat for the Obama administration, which had urged the justices to uphold the law.
In papers filed with the court, U.S. Solicitor General Donald B. Verrilli Jr. had written that “states have plenary authority to tax the entire income, wherever earned, of their own residents, who directly benefit from the services funded by income taxes and who collectively have the political power to achieve the repeal of any undesirable laws.”
But Alito, in the majority opinion, derided as “fanciful” the state and federal governments’ argument that victims of this “double taxation” can change the law at the polls.
“It is likely that only a distinct minority of a state’s residents earns income out of state,” Alito wrote.
“Schemes that discriminate against income earned in other states may be attractive to legislators and a majority of their constituents for precisely this reason,” he added. “In short, [the state’s] argument would leave no security where the majority of voters prefer protectionism at the expense of the few who earn income interstate.”
Alito was joined in the opinion by Chief Justice John G. Roberts Jr. and Justices Anthony M. Kennedy, Stephen G. Breyer and Sonia Sotomayor.
In dissent, Justice Ruth Bader Ginsburg said states may tax income already taxed in another state without imposing an unconstitutional restraint on interstate commerce.
“A taxpayer living in one state and working in another gains protection and benefits from both — and so can be called upon to share in the costs of both states’ governments,” Ginsburg wrote.
“This case is, at bottom, about policy choices: Should states prioritize ensuring that all who live or work within the state should their fair share of the cost of government? Or must states prioritize avoidance of double taxation?” Ginsburg added. “Resolving the competing tax policy considerations this case implicates is something the court is even less well equipped to do. For a century, we have recognized that state legislatures and the Congress are constitutionally assigned and institutionally better equipped to balance such issues.”
Ginsburg was joined in her dissent by Justices Antonin Scalia and Elena Kagan.
Scalia, in a separate dissent, wrote that the Commerce Clause merely empowers Congress to regulate commerce among the states.
“The clause says nothing about prohibiting state laws that burden commerce,” Scalia wrote in a dissent Justice Clarence Thomas joined. “Much less does it say anything about authorizing judges to set aside state laws they believe burden commerce.”
Thomas, in a separate dissent joined by Scalia, said the court’s decision “would have come as a surprise to those who penned and ratified the Constitution.”
State income taxes at the time of ratification did not provide credit for income taxes paid elsewhere, Thomas said.
“It seems highly implausible that those who ratified the Commerce Clause understood it to conflict with the income tax laws of their ststes and nonetheless adopted it without a word of concern,” Thomas added.
The statute at issue, Maryland Tax-General Article Section 10-703(a), allowed state residents to deduct the income taxes they pay to other states from their Maryland tax. However, the state said the provision does not apply to the “piggyback” tax the state collects on behalf of local governments.
The local taxes for the 2015 tax year range from a low of 1.25 percent of taxable income in Worcester County to a high of 3.2 percent in Baltimore city and Howard, Montgomery, Prince George’s, Queen Anne’s and Wicomico counties, according to the Maryland comptroller’s office.
Montgomery County Executive Isiah “Ike” Leggett stated in a letter Monday that the high court’s decision is expected to cost the county between $8 million and $10 million in fiscal 2016, which begins July 1, a shortfall that may exceed $50 million the following year due to lost tax revenue and refunds.
“As we have done in the past, we will continue to work closely with the [county] council to jointly and comprehensively address this challenge to maintain the county’s strong financial position going into the future and ensure the continuity of essential services,” Leggett wrote in the letter to Montgomery County Council President George Leventhal.
Baltimore County spokesman Don Mohler said the county expects a $5 million annual reduction in tax receipts as well as owing $30 million in tax refunds dating to 2009 as a result of the court’s decision. About 5,000 county taxpayers are affected, he added.
“Obviously, in a tight budget prepared with very little wiggle room, our budget folks will have to roll up their sleeves,” Mohler said. “The impact is not insignificant.”
Brian and Karen Wynne challenged the law after the comptroller said they could not deduct from their Howard County tax bill the $84,550 they paid in income taxes to other states in 2006.
The Wynnes’ out-of state income was derived from Brian’s ownership share in Maxim Healthcare Services Inc., a Columbia company that operates nationwide.
The Maryland Tax Court, an administrative agency, ruled for the comptroller but was overturned in 2011 by a judge in Howard County Circuit Court.
The Court of Appeals took the case, heard argument in May 2012 and issued its holding for the Wynnes on Jan. 28, 2013.
Without the tax credit, “a taxpayer with income sources in more than one state will consistently owe more in combined state income taxes than a taxpayer with the same income sources in just the taxpayer’s home state,” Judge Robert N. McDonald wrote for the five-judge majority. “This may discourage Maryland residents from engaging in income-earning activity that touches other states.”
In dissent, Judge Clayton Greene Jr. said the state’s denial of an out-of-state tax credit for city and county taxes is not only constitutional, but also ensures fairness among neighbors, not all of whom might have earned income outside of Maryland.
“[I]f the taxpayers were allowed to pay a lesser amount of county income tax, it would have the possible absurd result of the taxpayers paying little or no local tax for services provided by the county while a neighbor with similar income, exemptions and deductions might be paying a substantial local tax to support those services,” Greene wrote.
The Maryland court had stayed its decision pending ultimate resolution by the Supreme Court.
The Supreme Court issued its decision in Maryland Comptroller v. Wynne, No. 13-485.
— Daily Record reporter Bryan P. Sears contributed to this article.