Supreme Court Mandates State Income Tax Credits, Pretty Much

Maryland imposes income taxes on its residents. There is a state level income tax, and a county level tax. If a Maryland resident incurs income in other states and pays state income tax to those other states, there is a mechanism for the resident to receive a credit against the Maryland state level taxes for the non-Maryland taxes paid. This avoids double taxation of that income. However, there is no such credit mechanism for non-Maryland taxes paid in regard to the county level tax, so double taxes can result for those taxes.

The U.S. Supreme Court has ruled that the failure to provide such a credit for the county income taxes violates the Commerce Clause of the U.S. Constitution. Normally, the Commerce Clause only restricts federal laws that impede interstate commerce. Here, however, the violation was of what is known as the “dormant Commerce Clause” which is read to prohibit discriminatory state taxation even if Congress has not legislated on the subject.

The Court determined that the lack of a credit penalizes interstate commerce, as compared to intrastate commerce. It concluded this by testing whether interstate commerce produces more taxes than intrastate commerce, using the fiction that all states adopt the Maryland tax scheme at issue. Since interstate commerce generates double tax – a tax in each of the state where the activity occurs and the tax of residence, and since intrastate commerce (commerce conducting in the state of residence of the taxpayer) would only be taxed in the state of residence, interstate commerce is thus burdened with more taxes.

The Court notes that not all double tax consequences violate the dormant Commerce Clause. For example, if the nature of the double taxation arises from each state asserting different taxing systems (e.g., one taxes by source and one by residence), that might not violate the above test.

Thus, the Court appears to be requiring that a state taxing its residents on income must provide a credit for taxes imposed on the same income in other states. The majority opinion does say that there may be other constitutional means to avoiding double taxation other than a credit for taxes, but declines to name them or discuss them. So while it does not mandate a credit for taxes, that is the only route as of now that the Court acknowledges avoids constitutional infirmities.

The opinion should apply to similar arrangements in other states that do not offer the credit – not good news for those states.

Comptroller of the Treasury of Maryland v. Wynne, U.S. Supreme Court, Case No. 13-485 (2015)