Taxpayers Backed by U.S. High Court on Out-of-State Income

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The U.S. Supreme Court ruled that Maryland must reduce taxes on residents who earn money outside the state, in a decision that raises questions about tax-collection efforts across the country.

The justices, voting 5-4, said Maryland violated the Constitution by not letting a couple use the income taxes they paid elsewhere to reduce the amount they owe under a 3.2 percent county tax.

The ruling is likely to cut Maryland’s tax receipts by tens of millions of dollars a year and perhaps mean reductions of even larger sums elsewhere. Among the jurisdictions that might be affected is New York, which was a focus of discussion during arguments in November because of the municipal income tax in New York City.

The residents, Brian and Karen Wynne, said the Maryland law subjected them to thousands of dollars in double taxation. The dispute stemmed from money Brian Wynne collected in 2006 as part-owner of Maryland-based Maxim Healthcare Services Inc.

The couple reported taxable net income that year of $2.7 million, more than half of which was “pass-through” income earned by Maxim. The Wynnes claimed an $84,000 Maryland tax credit, saying it was warranted to offset taxes Maxim paid in other states.

Maryland said that while the Wynnes could claim that credit to lower their state taxes, they couldn’t reduce the 3.2 percent tax they are required to pay as Howard County residents.

Interstate Commerce

The high court said the Maryland tax system unconstitutionally discriminated against interstate commerce. Writing for the court, Justice Samuel Alito said the Maryland system “operates as a tariff” on income earned outside the state.

Were it adopted by all 50 states, Maryland’s tax system would result in higher rates on income earned out-of-state than on money earned in-state, he said.

The case split the court along unusual lines. Joining Alito in the majority were Chief Justice John Roberts and Justices Stephen Breyer, Anthony Kennedy and Sonia Sotomayor. Justices Antonin Scalia, Clarence Thomas, Ruth Bader Ginsburg and Elena Kagan dissented.

The high court didn’t directly address how its reasoning might affect other jurisdictions. New York residents who pay taxes elsewhere can claim a credit against their state income taxes but not against the municipal income taxes in New York City and Yonkers.

Potential Winners

Among the potential winners from Monday’s decision are New York City residents who earn income in New Jersey, California, Oregon and other states with top income tax rates higher than New York State’s 8.82 percent, said Dan Effron, practice leader for Marcum LLP’s state and local tax practice.

Some of those people currently don’t use up all of their tax credits offsetting the New York State tax. Under the court’s ruling, they could challenge New York on the prohibition against using those credits to offset the city’s income tax, which has a top rate of 3.876 percent, he said.

“Should New York City be forced or compelled to allow a tax credit, it could cost the city of New York significant tax dollars, just like this will cost the localities and counties in Maryland,” said Effron.

New York ‘Closest’

New York City’s tax “might be the closest” to Maryland’s unique system, said Joe Henchman, vice president of legal projects at the Tax Foundation in Washington.

Henchman said the court established an important rule that will govern future cases.

“There’s a majority that is going to look to make sure that whatever your tax is, if every state had that tax, it doesn’t result in multiple taxation,” Henchman said. “Everybody kind of thought that was the rule, but the Supreme Court hadn’t said it.”

Sonia Alleyne, a spokeswoman for the city Finance Department, said officials are reviewing the decision and declined to comment further.

Ruth Mason, a law professor at the University of Virginia, said states can make their tax systems comply with the law without necessarily offering a full credit for out-of-state income. Maryland’s system was an “outsider,” limiting the immediate effect of the decision, she said.

Maryland, however, will take a financial hit from the decision, which also opens the state to refund claims.

The ruling “creates severe challenges for counties looking to meet the education, public safety and infrastructure needs of Marylanders,” said David Nitkin, a spokesman for Maryland Attorney General Brian Frosh.

The case is Comptroller of Treasury v. Wynne, 13-485.