ANNAPOLIS — Costs to local and municipal governments related to a U.S. Supreme Court decision on some local tax payments could grow beyond an initial $140 million estimate if eligible taxpayers successfully challenge an interest rate set by the state on the outstanding refunds.
The Supreme Court last month ruled that the local governments could not apply piggyback taxes on income earned out of state if taxes were paid in the other jurisdiction. The General Assembly last year set the interest rate on the protected claims, which stretch back to 2007, at about 3.25 percent — well below the 13 percent that the state collects on late tax filings or pays out if they hold a refund in excess of 45 days.
“That seems like, I can’t believe it will hold up,” said Sen. Edward J. Kasemeyer, D-Howard and Baltimore Counties and chairman of the Senate Budget and Taxation Committee. “It seems contrived.
State officials Tuesday estimated that local governments will have to pay out as much as $140 million on protected tax filings before any challenges to the state’s simple interest rate.
“We’re giving them 3 percent and giving ourselves 13,” Kasemeyer said.
Nearly 10,000 protected claims have been filed. State officials believe that as many as 55,000 claims could be filed for other years in which the statute of limitations has not expired.
Deputy Comptroller David F. Roose said limiting the interest saves local and municipal governments $40 million to $60 million, but he acknowledged the potential legal concerns.
“It will likely be challenged,” Roose said.
In May, the Supreme Court ruled that local and municipal governments could not collect piggyback taxes on income earned in other states if taxes were paid in those states. The ruling primarily affects businesses. Most individual taxpayers who work in Pennsylvania, Virginia, Washington, D.C., and West Virginia do not pay taxes on wages earned in those states. Those who work in Delaware but live in Maryland could seek a refund through an amended return for as far back as 2011. And if they filed protective claims for previous years, they could claim even larger refunds.
“There is a significant impact on local and municipal governments for prior periods and an ongoing impact forever more,” said Deputy Comptroller David F. Roose during testimony before the Senate Budget and Taxation Committee Tuesday.
Some counties have started setting aside money to pay for the back claims. The state will pay out the refunds on the protected filings from a reserve account set aside for local income taxes and allow the counties to repay that money over nine quarters beginning in fiscal 2017.
Sen. Richard S. Madaleno Jr., D-Montgomery County and vice chairman of the Budget and Taxation Committee, noted that the interest paid on the returns will ultimately come from local taxpayers.
“If one of the wealthiest people who is getting one of the refunds goes to court to seek a class-action lawsuit to get the full amount of the penalty, all they would be doing is in fact suing their neighbors to get that money back,” Madaleno said.
Montgomery County will take the biggest tax hit in terms of dollars as a result of the ruling.
Andrew Schaufele, director of the Bureau of Revenue Estimates, said the county will be on the hook for as much as $25 million of the estimated $40 million reduction in local tax collections annually. That figure represents about 2 percent of the county’s annual income tax collections.
Smaller municipalities could see greater effects because the number of taxpayers is smaller.
“I think certainly when you start talk about the municipalities, some have 40 or fewer taxpayers, just as is always the case, that the income of many of these municipalities is always volatile because of the nature of taxpayers, this could just be adding to the volatility that some of the state’s smaller but very wealthy municipalities have to deal with,” Roose said.
Cecil County will lose about $1.3 million or roughly 3 percent of its income tax collection annually — the most of any county in the state.
Schaufele attributed the relatively high percentage to the number of people who commute to work in Delaware. So far, the county has seen few claims for refunds from previous years.
“It’s not terribly surprising to not see claims because wage earners don’t likely have tax accountants urging them to file claims,” Schaufele said.