Thursday, May 21, 2015
The Supreme Court this week upheld Maryland's income tax system against a Dormant Commerce Clause challenge. The sharply divided ruling put on full display the Court's fault lines in this area, even as the five-Justice majority set out a bright line test for tax challenges under the Dormant Commerce Clause.
Our preview of the case, Comptroller v. Wynne, is here, with the full factual background. In brief: Maryland income tax consists of a state tax and a county tax. Residents who pay income tax to another jurisdiction (because they earn income there) are allowed a credit against the state tax, but not the county tax. This means that residents who earn out-of-state income are taxed on that income by the other jurisdiction, and by Maryland (under the county tax). (For out-of-staters earning income in Maryland, Maryland imposes a state income tax and a "special resident tax" (in lieu of the county tax).) Maryland residents who earned pass-through income from an S-corporation that earned income in several states sued, arguing that the "double taxation" violated the Dormant Commerce Clause.
The Court disagreed. Justice Alito wrote for the majority, joined by Chief Justice Roberts and Justices Kennedy, Breyer, and Sotomayor. Justice Alito wrote that the case was an easy application of precedent and the "internal consistency test." That test asks whether, if every state adopted the challenged tax structure, taxes would "inherently discriminate against interstate commerce without regard to the tax policies of other States." If so, the category of taxes "is typically unconstitutional." Justice Alito said that Maryland's tax system violated the rule, because a Marylander earning out-of-state income would be taxed on that income twice (once by the out-of-state jurisdiction, and once by the Maryland county), whereas a Maryland earning in-state income would be taxed only once.
Justice Ginsburg dissented, joined by Justice Scalia and Kagan. She argued that there's a long history "of States imposing and this Court upholding income taxes that carried a similar risk of double taxation," and that the majority's internal consistency test is deeply flawed. She also argued that "[f]or at least a century, 'domicile' has been recognized as a secure ground for taxation of residents' worldwide income," and based on the domicile principle Maryland's tax system (of its own residents) is valid. Justice Ginsburg gave several reasons for this principle, including the benefits that residents receive and the political influence that residents wield--both hotly disputed by Justice Alito. Justice Ginsburg also argued that the cases relied on by the majority involved gross receipts taxes, not income taxes. She said that the difference matters: "For decades--including the years when the majority's 'trilogy' was decided--the Court has routinely maintained that 'the difference between taxes on net income and taxes on gross receipts from interstate commerce warrants different results' under the Commerce Clause."
Finally, Justices Scalia and Thomas dissented separately, maintaining their positions that there is no Dormant Commerce Clause.
The upshot of this fractured ruling is that the internal consistency test is the rule for Dormant Commerce Clause challenges to state tax practices, and that the Court will strike tax practices that result in this kind of "double taxation" of out-of-state income.