Maryland Court Of Appeals Rules Denial Of County-Level Tax Credit For Taxes Paid To Other States Violates Commerce Clause

The Maryland Court of Appeals has ruled that the failure of Maryland law to allow a credit against county income tax for Maryland residents for their pass-through income from an S corporation's out-of-state activities that was taxed by another state was unconstitutional.1 The Comptroller had denied application of the credit with respect to the taxpayers' county-level tax liability, which according to the Court, tended to discourage taxpayer shareholders of S corporations from conducting business outside Maryland and discriminated against interstate commerce in violation of the dormant Commerce Clause.2

Background

The taxpayers, a married couple residing in Howard County, Maryland, held an ownership interest in a federal S corporation providing health care services on a nationwide basis. On both their 2006 federal and Maryland income tax returns, the taxpayers reported a portion of the income of the S corporation as "pass-through" income. On the Maryland return, the taxpayers claimed a credit against their individual income tax for taxes paid to other jurisdictions. The S corporation had filed state income tax in 39 different states and allocated to each shareholder a pro rata share of taxes paid.3 The Maryland Comptroller only allowed the taxpayers to apply the credit against their state taxes owed, disallowing the credit against local taxes owed and resulting in the issuance of an assessment against the taxpayers.4 The Hearings and Appeals Section of the Comptroller's Office subsequently affirmed the assessment and the taxpayers appealed to the Maryland Tax Court. Before the Tax Court, the taxpayers, for the first time, argued that the Comptroller's limitation of the credit (for tax payments made to other states) to the Maryland state-level tax, discriminated against interstate commerce in violation of the Commerce Clause of the U.S. Constitution. The Tax Court rejected the taxpayers' argument, ruling in favor of the Comptroller. The taxpayers subsequently sought judicial review in the Circuit Court for Howard County. After the circuit court reversed the Tax Court's decision, the Court of Appeals ultimately granted certiorari.

At issue before the Court of Appeals was whether the denial of the taxpayers' credit for out-of-state income taxes paid against their Maryland local tax (county tax) liability violated the Commerce Clause.

Dormant Commerce Clause Violated

Implication of Dormant Commerce Clause

The Court of Appeals determined that the denial of the credit for out-of-state income taxes paid, with respect to the taxpayers' county-level income tax liability, "implicated" the dormant Commerce Clause, which prohibits a state from unjustifiably discriminating against or unreasonably burdening interstate commerce. In particular, the limitation of the credit raised concerns over the variance in treatment of a Maryland resident taxpayer who earns...