Can Maryland Collect Taxes on Out-of-State Income?
By Ian Duncan
With $50 million a year in county revenues on the line, the U.S. Supreme Court said Tuesday it would hear a challenge to a ruling by Maryland's highest court that some taxes on out-of-state income are collected in violation of the Constitution.
A Howard County business owner and his wife challenged the tax laws, arguing that they were being taxed twice on some income. The Maryland Court of Appeals agreed in a ruling last year, saying that the state's power to levy taxes on income earned outside its borders is limited.
The case was a victory for taxpayers but is being nervously watched by officials in Maryland's local governments, who face the prospect of lost revenue and having to pay millions of dollars in refunds. Some fear the case could upend local tax collection nationwide.
The case revolves around the unusual way that income earned in other states is treated by Maryland law. States that levy an income tax typically offer credits for income taxes paid to other states, but Maryland collects both a state tax and a county tax, and treats credits for the two differently.
Residents can claim credits for income tax paid to other states only against the portion used to fund the state budget, not the part reserved for local governments, typically leading to higher overall taxes on out-of-state income.
The Maryland attorney general's office asked the Supreme Court to hear the case, arguing that the Maryland appellate ruling would make the state's tax system unfair. The U.S. solicitor general sided with Maryland, urging the nation's top court to get involved.
"The Court of Appeals has mandated a new tax system under which certain Maryland residents ... can obtain all the benefits granted to other Maryland residents, without having to pay their full share of the bill," the state attorney general's office wrote in its petition to the Supreme Court.
The justices granted Maryland's request to hear the case in a single-line order Tuesday.
"We are pleased that the Supreme Court has recognized the significance of this issue to Maryland and its local governments," said David Paulson, a spokesman for the state attorney general.
Dominic Perella, an attorney for the couple, Brian and Karen Wynne, said that his clients are confident of victory and that Maryland's approach could ultimately hurt businesses.
"We expect the court to reject Maryland's view that states can double-tax their residents as much as they see fit," he said. "Maryland's approach is unfair to people who make money in more than one state."
The Wynnes, who earned income from a stake in a business that operated across the United States, challenged their 2006 tax calculation, and their attorneys argued in court that the state's credit rules led to some of their income unconstitutionally being taxed twice.
The state has argued in court papers that it has wide powers to tax its residents, even if that means some double taxation.
Judge Robert N. McDonald wrote for the majority in the Maryland Court of Appeals that the law "creates a disincentive for the taxpayer ... to conduct income-generating activities in other states with income taxes" and violates the Commerce Clause of the Constitution.
The appellate court put its ruling on hold while the Supreme Court looks at the case, but the state comptroller's office said it has already received 7,000 claims from taxpayers who would seek refunds if the decision stands.
Counties could be on the hook to pay up to $190 million in refunds, according to estimates by state officials.
Should the ruling stand, its impact in Maryland would likely be blunted by agreements the state has with Pennsylvania, Virginia and the District of Columbia to treat income earned by Maryland residents in those jurisdictions as though it was earned here.
But the Maryland Association of Counties has said commuters who work in Delaware, which has no such agreement, could be affected, as could Montgomery County, which has a high proportion of wealthy residents who earn a living through business activities in multiple states.
Andrea Mansfield, the association's legislative director, said it will be following the case closely.
"This is a really big important issue for a number of counties," she said.
And in a friend-of-the-court brief filed with the Supreme Court, a group of organizations representing local governments urged the justices to reverse the Maryland decision and stave off potential attacks on other tax regimes. If the Maryland court is right, the organizations' attorneys wrote, then the Constitution "requires that states and their subdivisions rewrite their tax codes and continue to provide essential services to residents who may pay little or nothing for them."
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