Argument preview: The scope of the states’ constitutional authority to tax the personal income of their residents
on Oct 28, 2014 at 8:00 am
Bradley W. Joondeph is the Inez Mabie Distinguished Professor and Associate Dean for Academic Affairs at the Santa Clara University School of Law.
How broad is the states’ power to impose personal income taxes on their own residents? More specifically, what steps does the Constitution require of states, if any, to ensure that such taxes do not result in the multiple taxation of income earned by their residents in other states? That is the crux of the question in Comptroller v. Wynne, scheduled for oral argument on November 12.
It is somewhat surprising that such a basic issue remains unresolved this far into the nation’s history. But most states with personal income taxes afford their residents a credit for taxes paid to other states on the same increments of income. Maryland does not – at least not in full. With respect to one component of its income tax, Maryland taxes the entirety of its residents’ incomes, no matter what. This case thus presents an important, unanswered question: Does the dormant Commerce Clause permit a state to collect a tax on all of a resident’s personal income, even when a portion of that income is earned in – and taxed by – another state?
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Brian and Karen Wynne are married and reside in Howard County, Maryland. In 2006, they earned a substantial portion of their income through their part-ownership of Maxim Healthcare Services, a Subchapter S corporation. S corporations are “pass-through” entities, such that their income is not taxed at the corporate level, but instead reported on their owners’ personal returns. Much of Maxim’s income was earned outside Maryland, and the Wynnes were taxed by these other states on the income earned by Maxim therein.
Maryland’s personal income tax comprises two distinct components, both of which are collected by the state: a state component, retained by the state government, and a county component, which is remitted by the comptroller to the taxpayer’s county of residence. Like other states, Maryland nominally imposes its tax on the entirety of its residents’ income, regardless where that income is earned. With respect to the state component, Maryland affords its residents a credit for taxes paid to other states on the income earned in those states. But Maryland offers no such credit against the county component. Consequently, Maryland residents earning out-of-state income that is taxed by another state are taxed twice on that income – once by the state where it was earned, and then by Maryland (in the county component of its tax).
The Wynnes contested their 2006 state income tax liability, arguing that Maryland’s failure to afford them a credit against the county component of the tax violated the dormant Commerce Clause. The Maryland Court of Appeals (the state’s highest court) agreed, concluding that Maryland’s scheme violated two prongs of the doctrinal test originally announced by the Supreme Court in Complete Auto Transit v. Brady. First, the scheme was not “fairly apportioned” because it was “internally inconsistent.” (Importantly, Maryland also imposes the county component of its tax on the income earned by nonresidents within Maryland.) Maryland’s scheme lacked internal consistency because, were every state to adopt it, persons earning income exclusively within their state of residence would be taxed just once, while persons earning income in multiple states would be taxed twice on their out-of-state income. Second, the court found that Maryland’s scheme discriminated against interstate commerce: by subjecting residents’ out-of-state income to multiple taxation, it favored intrastate over interstate activity.
After Maryland petitioned for certiorari, the justices called for the views of the Solicitor General. He agreed that cert. was warranted, and on May 27 the Court granted review.
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Wynne lies at the confluence of three basic constitutional principles in the field of state taxation. First, as the Court has held on several occasions, states have the authority “to tax all income of their residents, including income earned outside their borders.” (This is often called residence-based jurisdiction.) Second, states also have the authority to tax the income of nonresidents, but only to the extent of the income earned within the state’s borders. (This is often called source-based jurisdiction.) Third, as a general rule, taxes resulting in multiple state-level taxation of the same value – whether that value be income, property, or something else – violate the dormant Commerce Clause, as they subject interstate commerce to a burden intrastate commerce does not shoulder.
Each of these points is undisputed. The question is how they are to be reconciled here.
Crucially, Maryland frames its argument by contending that a state’s residence-based authority to impose a personal income tax is special – “a natural counterpart to the special obligations that states assume with respect to those residents.” It is therefore qualitatively different from a state’s source-based jurisdiction to tax a nonresident’s income.
States “provide a host of benefits that are unavailable to nonresidents,” typically costing tens of billions of dollars, including primary and secondary schools, public colleges and universities, a broad array of public assistance programs, and health benefits under Medicaid. Were Maryland required to grant taxpayers like the Wynnes a complete credit for taxes paid to other states, residents earning their incomes outside the state might pay nothing in personal income tax to Maryland, despite receiving full access to all these benefits. What’s more, those disadvantaged by Maryland’s tax scheme are Maryland taxpayers. If they feel the state’s tax policy is misguided, “they can give effect to their views by voting for various forms of lower taxes, including more generous credits for out-of-state tax payments.”
Maryland next explains that, were the state of residence required to provide the credit the Wynnes seek, it would be forced to yield its valid claim to revenue whenever a “source” state imposed a personal income tax on a Maryland resident. But “the Constitution contains no such rule of enforced priority.” Assuming both states have jurisdiction to tax the income, argues Maryland, there is no constitutional “provision specifying that a state in which a taxpayer earns income has greater taxing authority than a state in which a taxpayer resides.” If anything, the state of residence has the stronger claim.
Maryland also submits that, though the Court has invalidated several state taxes for producing duplicative burdens, the Constitution contains no “absolute bar to multiple taxation.” Decisions like Moorman Manufacturing Co. v. Bair illustrate that some forms of multiple taxation are simply a bi-product of federalism. Relatedly, Maryland argues that the “fair apportionment” test is inapt in assessing the constitutionality of a personal income tax imposed by a state on its own residents. Though measured in income, such taxes are grounded in the special relationship a state enjoys with its own citizens – a relationship unlike that with nonresidents, who merely derive income from within the state’s borders. Because taxpayers enjoy the benefits of domicile in exactly one state, apportionment is beside the point.
Participating as an amicus, the United States adds one more argument worth mentioning. To the extent Maryland’s scheme is internally inconsistent, contends the government, it is attributable to the county component of the tax Maryland imposes on nonresidents (on the income they earn in Maryland). The tax Maryland imposes on its residents – the tax the Wynnes actually challenge – fully comports with the internal consistency test. Thus, if there is an internal consistency problem, the Wynnes lack standing to raise it.
In response, the Wynnes make one basic contention: The Commerce Clause forbids any state tax that creates a risk of multiple taxation. “Since 1938, this Court’s Commerce Clause jurisprudence has invalidated state tax laws that subject a State’s domicilaries to multiple taxation, or the risk thereof, as the consequence of engaging in interstate commerce.”
The Wynnes readily concede that Maryland can tax the entirety of its residents’ incomes, wherever earned. Thus, had the Wynnes earned their out-of-state income in states without personal income taxes, Maryland could have collected a tax on one hundred percent of their income. But according to the Wynnes, “[w]hen two or more States have jurisdiction to tax the same income, the Commerce Clause requires a credit, division of the tax base, or some other mechanism to eliminate the risk.” The Court has invalidated state taxes on this ground several times before; stare decisis “command[s] that the outcome here should be the same.”
The Wynnes also echo the reasoning of the Maryland Court of Appeals, arguing that Maryland’s tax scheme is not fairly apportioned and discriminates against interstate commerce. It is not fairly apportioned because it is internally inconsistent; and it discriminates against interstate commerce because Maryland residents who earn out-of-state income are taxed twice, a duplicative burden not faced by residents confining their income-earning activity to Maryland alone.
Finally, the Wynnes contend that upholding Maryland’s tax would produce a “bizarre and unjust result.” In their view, it is well established that state income taxes imposed on C corporations – taxes imposed on corporations as entities – must be apportioned based on the income they earn within the taxing state, even when the tax is imposed by the state of domicile. (The federal government argues that this remains an open question.) If Maryland’s tax were constitutional, “States could not double-tax C corporations, but they could double-tax S corporations, other pass-through entities, and small businesspeople to their hearts’ content.”
The list of participating amici speaks to the case’s significance. In addition to the federal government, the Multistate Tax Commission and the International Municipal Lawyers Association (represented by Paul Clement) have filed briefs supporting Maryland. Eleven groups, including the U.S. Chamber of Commerce (represented by Jeffrey Lamken) and the Maryland Chamber of Commerce (in a brief co-authored by Walter Hellerstein, the dean of state tax experts), have filed in support of the Wynnes.
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Several Supreme Court decisions have invalidated state taxes on the ground that they subjected interstate commerce to the risk of multiple taxation. But the Court has never invoked this prohibition to invalidate a personal income tax that a state imposed on its own residents — on income the state plainly had jurisdiction to tax. Further, if multiple taxation is indeed verboten in this context, it is unclear why the state of residence is necessarily to blame. With respect to personal income taxes, the Court has never even suggested which of the two taxing states – the state of residence, or the state in which the income is earned – should take constitutional precedence.
Ultimately, the case seems to turn on whether the Justices consider a personal income tax, imposed by a state on its own residents, qualitatively different from taxes imposed on corporations or nonresidents. If so, Maryland’s decision to collect a tax on one hundred percent of its residents’ income (without any sort of offsetting credit) would seem justified, a reflection of the special relationship between a sovereign and the natural persons residing within its borders. But if the Court sees Maryland’s tax – at least for purposes of the dormant Commerce Clause – as indistinct from other taxes a state might impose on interstate business activity, Maryland’s scheme almost certainly must fall, as it flunks two long-standing doctrinal requirements: it virtually assures that residents earning out-of-state income will be subjected to multiple taxation, and it systematically favors intrastate over interstate commerce.
This case presents a fascinating collision between the imperatives of state sovereignty and free markets – between the states’ autonomy in matters core to their separate existence, and the axiom that commerce among the states must be protected from parochial trade barriers. State tax disputes generally don’t raise fundamental questions about the role of the states in our constitutional structure. But this one does.