Maryland, like all states with an income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. , gives taxpayers a credit for income taxes paid to other states. However, since 1975, Maryland has only allowed taxpayers to use the credit to offset state income taxes, not local income taxes. Each county in Maryland (plus Baltimore City) imposes a local income tax, with rates of up to 3.2 percent. (16 other states impose local income taxes.)
Taxpayer Brian Wynne has challenged the state’s practice. Wynne is one of seven owners of Maxim Healthcare Services, which was an S CorporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). operating in several states. Because Maxim was an S Corporation, the income flowed through to the owners, including Mr. Wynne. He reported his share of the corporation’s income on his state income tax return and claimed a credit for income taxes paid to other states. The Comptroller’s office adjusted his credit to disallow the portion of the credit that offset his county income taxes, which resulted in a substantially higher income tax bill. Mr. Wynne filed suit and the Maryland Tax Court ruled in favor of the Comptroller. The appeals court reversed, finding for Wynne. The highest court in Maryland, the Court of Appeals, also sided with Wynne.
The Court of Appeals primarily held that the denial of a credit to offset county income taxes violated the Constitution because it discriminated against interstate commerce. Specifically, the court pointed out that taxpayers whose income is derived wholly in-state would have lower tax bills than similarly situated taxpayers who earn part of their income in other states. This burdens interstate commerce by discouraging individuals from entering into and participating in markets in other states. The court also pointed out that this problem would be alleviated if the state allowed taxpayers to offset county income taxes with a credit for taxes paid to other states, as other states do and as the state does with state income taxes.
Maryland is now appealing to the U.S. Supreme Court, which in turn has asked the U.S. Solicitor General to give his opinion on Maryland’s practice of not allowing taxpayers to use credit for taxes paid to another state to offset local income tax liability.
The Court of Appeals is correct that not allowing a taxpayer who pays income taxes to other states to offset county income taxes results in double taxation and discourages active participation in interstate markets. Those of us interested in sound tax policy can only hope that the Supreme Court doesn’t take the case or, if they do, that they uphold the Court of Appeals’ decision.
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