In Landmark Case, Supreme Court Finds Maryland’s Tax Scheme Unconstitutional

Last May, Dominic Perella, argued that the way that the State of Maryland treated tax credits was wrong, arguing, “Maryland’s approach is unfair to people who make money in more than one state.”

As it turns out, the Supreme Court agrees, holding in Comptroller v. Wynne that Maryland’s tax scheme is unconstitutional because it doesn’t offer credit to its residents for taxes paid in other states.

This – as it applies both to state and local tax policy – is a big deal. To understand the case, we need to understand the context. How did this case find its way to the Supreme Court? Here are the details:

A married couple (the Wynnes) reported taxable net income of approximately $2.7 million to the State of Maryland. More than half of that amount represented a share of earnings in an S corporation with operations in several states. The Wynnes claimed a credit on their Maryland tax returns for taxes paid to 39 other states. The State of Maryland denied the credits and issued a notice of deficiency. The Wynnes appealed. At a hearing, the assessment was affirmed, meaning that the Wynnes were stuck paying the tax.

The Wynnes disagreed with the finding and amended their petition, claiming that the tax credit statute, as written, was in violation of the Commerce Clause of the United State Constitution. That claim was rejected.

So the Wynnes tried again, arguing this time that the State of Maryland was constitutionally required to extend the credit for taxes paid to other states to the county as well as the state. Their bigger question was whether a state had the unconditional right to tax all income based on residency (they, of course, said no). This time, the Circuit Court agreed with the Wynnes.

The State of Maryland appealed and lost with the Court of Appeals finding that the Constitution prohibits “double taxation” of income earned in interstate commerce. That means, the Court found, that a state may not simply tax all the income of its residents no matter where it is earned.

As you can imagine, the state of Maryland wasn’t thrilled with this finding. The state warned that this would result in a “significant loss of revenue that will amount to tens of millions of dollars annually.” So the state appealed. Again. Only there was one small problem. After Appellate Court, there’s really nowhere to go – except the Supreme Court.

The Supreme Court did not have “original jurisdiction” over this matter so the losing party (in this case, the State of Maryland) had the option of filing a petition to ask the Supreme Court to hear it. That’s what the State of Maryland did and the Supreme Court opted to hear it. That’s referred to as granted certiorari (or, for the cool, hipster kids who like to shorten their Latin, granted cert).

The case garnered a lot of attention. That’s because the case isn’t just about the Wynnes. Or Maryland. Even the State of Maryland acknowledged as much in its original petition, noting that the matter “has potential repercussions beyond Maryland.” The question of whether a jurisdiction – not just Maryland – can impose tax on its residents’ entire income even when that income may be subject to taxes elsewhere has nationwide implications.

The finding by the Supreme Court was, on its face, simply, “Maryland’s personal income tax scheme violates the dormant Commerce Clause.”

The Court leaned heavily on the Commerce Clause, found at Art. I, § 8, cl. 3 of the Constitution, which gives Congress the right:

To regulate commerce with foreign nations, and among the several states, and with the Indian tribes;

The Supreme Court noted that “we have consistently held this language to contain a further, negative command, known as the dormant Commerce Clause, prohibiting certain state taxation even when Congress has failed to legislate on the subject.” It sounds like a sleeping giant but what it means is that states may not pass laws that discriminate against or excessively burden interstate commerce.

The majority went on to distinguish between “(1) tax schemes that inherently discriminate against interstate commerce without regard to the tax policies of other States, and (2) tax schemes that create disparate incentives to engage in interstate commerce (and sometimes result in double taxation) only as a result of the interaction of two different but nondiscriminatory and internally consistent schemes.” The first, the Court found, is unconstitutional while the second is not.

The majority also noted that the discriminatory nature of Maryland’s tax structure “is not simply the result of its interaction with the taxing schemes of other States.” Rather, the court found that Maryland’s tax scheme is “inherently discriminatory and operates as a tariff.” Why does that matter? Remember Chief Justice Roberts’ commentary in the Health Care decision a few years back about a penalty versus a tax? Words matter. And the majority’s finding that the tax scheme is basically a tariff “is fatal because tariffs are “[t]he paradigmatic example of a law discriminating against interstate commerce.” (West Lynn, 512 U. S)  The Court, continuing to cite West Lynn, wrote, “tariffs against the products of other States are so patently unconstitutional that our cases reveal not a single attempt by any State to enact one.”

As to Maryland’s “but we tax everyone at the same rate so it can’t be discriminatory” argument? The Court wasn’t buying it, saying that “the fact that the tax might have ‘the advantage of appearing nondiscriminatory’ does not save it…”

In the end, it all came down to this: “the total tax burden on interstate commerce is higher” under Maryland’s current tax scheme. That double taxation scheme, the Court found, is unconstitutional.

Justice Alito delivered the opinion, joined by Chief Justice Roberts, and Justices Kennedy, Breyer and Sotomayor.

There were dissents. Lots of dissents. You have to read the dissents. It’s like reading the minority reviews on Amazon.com – generally not going to change your mind but they do offer perspective and they’re often entertaining – as is the case here.

Justice Scalia filed a dissenting opinion, which Justice Thomas joined in part. In the dissent, Justice Scalia refers to the notion of the dormant Commerce Clause as “judicial fraud” – but he’s in the minority here. He further reacts to the Court’s claims that the dormant Commerce Clause doctrine “has deep roots” by arguing, “So it does, like many weeds.”

Justice Thomas also filed a dissenting opinion, which Justice Scalia joined in part. Justice Thomas likewise didn’t embrace the notion of the Commerce Clause but the majority found his argument “plainly unsound.”

And in the most odd bedfellows dissent of all, Justice Ginsberg filed a dissent, joined by Justices Scalia and Kagan. Justice Ginsberg quotes a prior finding from the Court that “It is not a purpose of the Commerce Clause to protect state residents from their own state taxes.”

A great deal of the dissents focuses on the “people versus corporations” debate that we’ve seen before… definitely interesting party conversation. The opinion knocks parts of these dissents in a rather feisty manner.

You can read the opinion together with the dissenting opinions here (downloads as a pdf).