U.S. Supreme Court Questions Out-of-State Income Taxes

The justices heard arguments Wednesday in a case that could cause localities across the country to lose millions in annual tax revenue.
by | November 12, 2014

While hearing a case Wednesday that could upend some localities’ ability to tax their residents' out-of-state income, U.S. Supreme Court justices focused largely on tax fairness for residents.

At issue is a dispute between Maryland residents Brian and Karen Wynne and the state controller over local taxes levied by Howard County, where the Wynnes live. As a partial owner of a national health-care corporation, Brian receives income in dozens of states. Maryland, like every state that taxes income, gives a state income tax credit to residents for income earned out-of-state. But, unlike many states, it doesn't give any credit for local taxes owed. This essentially means that the Wynnes and other Maryland residents pay taxes on their out-of-state income to the state where they work and the locality where they live.

The Wynnes argue the situation amounts to double taxation and is a violation of the Interstate Commerce Clause, which is the reason for the state-level tax credit. Maryland’s highest court agreed with the Wynnes last year, and now it’s up to the U.S. Supreme Court to rule in a decision that could have effects far beyond Maryland’s borders.

The justices' questions Wednesday generally focused on two topics. One was whether Maryland’s tax principles were consistent because it collects a local tax on income earned out-of-state but it also has a 1.25 percent tax on income earned in Maryland by non-residents. The other topic was on the fairness of excusing some residents from paying local taxes because they earn income elsewhere.

On the issue of Maryland taxing residents and non-residents' income, the court probed for Maryland’s rationale.

“How can you tax all the income earned within your border and income earned in other states?” asked Justice Samuel Alito. “Why shouldn’t this tax system meet exactly the same fate as a tariff?” (Tariffs between states are prohibited by the U.S. Constitution.)

U.S. Department of Justice attorney Eric Feigin, in defense of Maryland, argued against bringing the state’s non-resident tax into the discussion because the Wynnes hadn’t been subject to that tax. But the Wynne's attorney, Dominic Perella, argued that looking at ruling on taxing the “inbound” income opens up the door for the court to also rule on taxing the “outbound” income.

On the issue of the fairness, the justices’ wondered why, as residents who used their local resources, the Wynnes should be excused from paying all their local taxes. Justice Ruth Bader Ginsburg probed Perella about why it was fair that one resident pay nothing in local taxes while theoretically he or she could be sending five kids to the area’s public schools. Perella started to rationalize that Maryland was still benefiting because it was taxing non-residents but was interrupted by Chief Justice John Roberts who said, “This man is getting a free ride."

The case could have far-reaching implications, depending on the court’s ruling. In the broadest sense, a ruling against Maryland could wipe out as much as $50 million per year in state revenue and millions more annually for more than 2,000 municipal income taxes nationwide that may not provide credits for out-of-state income. The court could opt to narrow its opinion, making its ruling only applicable to S-corporation income (the type of income at issue for the Wynnes because the business is owned by shareholders.)

William Brockman, Maryland’s acting solicitor general, argued that any ruling against the state would compromise the state’s taxing power and be an extreme action to accommodate people who want to live in Maryland but work elsewhere.

“Well," responded Justice Antonin Scalia, "you’re relying on the principle that life is not fair.”

“Life isn’t fair, your honor,” Brockman said. “But Maryland taxes are.”