Tax Analysts Blog

Is the Dormant Commerce Clause in Jeopardy?

Posted on Aug 28, 2014

A case pending before the U.S. Supreme Court that has yet to grab the attention of the mainstream media is Maryland State Comptroller of Treasury v. Wynne. It’s a state tax case that is interesting because it could significantly change the scope of the dormant commerce clause. The dormant commerce clause is a principle inferred from the commerce clause, which restricts states from passing legislation that improperly discriminates against interstate commerce.

The facts in Wynne are not particularly complex. Brian Wynne and his wife are residents of Harris County, Maryland. They owned 2.4 percent of Maxim Healthcare Services Inc., an S corporation that was doing business in 39 states. In 2006, a substantial amount of income was passed through Maxim to the Wynnes. The Wynnes paid tax to most of the states in which Maxim did business.

As residents of Maryland, the Wynnes’ income was subject to Maryland income tax, which includes a state and county component. The county income tax is collected and administered by the state and is computed on the same tax base as the state income tax. For 2006, the Wynnes reported $2.7 million of income and $126,363 of Maryland state income tax. The state income tax rate was 4.75 percent. The Wynnes were also liable for county income tax at a rate of 3.2 percent. They claimed a credit of $84,550 for taxes paid to other states. The Maryland comptroller permitted the Wynnes to claim a credit against their state income taxes, but not against their county taxes. The Wynnes appealed.

When the case was heard before the Maryland Tax Court, the Wynnes argued that limiting their ability to claim a credit for taxes paid to other states was a violation of the dormant commerce clause. The tax court disagreed and the case made its way to the Maryland Court of Appeals (the state’s highest court), which held that the county income tax implicates the dormant commerce clause because it could affect interstate commerce. The court determined that without a credit, the county income tax was discriminatory and violated the dormant commerce clause because taxpayers who earn income from interstate activities would be taxed at higher rates than taxpayers who earn income exclusively from instate activities..

The comptroller appealed to the U.S. Supreme Court, which, somewhat surprisingly, granted certiorari. The question before the court is whether the federal constitution prohibits “states from taxing all the income of their residents by mandating a credit for taxes paid related to income earned in other states.” The answer to that question seems obvious. Yes, a state should be required to provide a credit for taxes paid in other states. Doing otherwise would validate double taxation.

But local governments have filed a brief saying a decision in favor of the Wynnes could be “dire” for municipalities. According to the brief, numerous states have income tax systems similar to Maryland and they simply cannot afford dollar-for-dollar credits for all out-of-state taxes paid.

Whether or not states and localities can afford to grant a credit should have no bearing on whether providing one is constitutionally required. But the case aptly demonstrates where the due process and commerce clauses collide. That is, the due process clause permits the state to tax all of the income of its residents. But, the dormant commerce clause prohibits discrimination against interstate commerce.

The real concern with this case is that Justices Antonin Scalia and Clarence Thomas have previously rejected the idea of a dormant commerce clause and could use this case to eliminate or significantly curtail dormant commerce clause jurisprudence. Such an opinion would be catastrophic for taxpayers. In matters of state taxation, the dormant commerce clause provides a much stronger defense against discriminatory taxation than the due process clause.

Wynne is worthy of attention. While the court could draft a very narrowly tailored opinion, it could also do something radical.

Read Comments (1)

bubba shawnAug 31, 2014

If I understand the issue correctly, a SC decision defending the dormant
Commerce Clause will have another devastating consequence upon municipal bond
investors. Curtailing states from income tax collections of any kind reduces
those states' abilities to pay the interest on those bonds and pay back the
principle at maturity.

The timing of this case can't be more inopportune with municipalities going
bankrupt and most states awash in unsustainable debt levels.

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