Dormant Commerce Clause Archives - The National Law Forum

On October 30, 1975, The Daily News published one of the most famous headlines in American history – Ford to City: Drop Dead – to paraphrase President Ford’s refusal to extend federal financial assistance to New York City to prevent the City from declaring bankruptcy. Nearly 40 years later, a different branch of the federal government delivered similarly unwelcome financial news to New York City (and to other municipalities and counties that impose income taxes). In Comptroller of the Treasury of Maryland v. Wynne, the United States Supreme Court held by a five-to-four majority that the county component of the Maryland state income tax violated the dormant Commerce Clause of U.S. Constitution as an unfairly apportioned tax because it applied, without the benefit of credit for taxes paid to other states, both to the world-wide income of county residents and to the income of nonresidents derived in the county.

While every state that levies an income tax affords its residents a credit for income taxes paid to other states, many of the 5,000 state political subdivisions that impose an income tax, including New York City and virtually all Ohio municipal corporations, do not allow their residents a credit for income taxes paid to other states. To comply with Wynne, these political subdivisions must either provide their residents a credit for income taxes paid to other states or cease assessing income tax on income derived in the political subdivision by nonresidents. Regardless of which alternative is chosen, these political subdivisions face significant revenue losses. For example, it is estimated that Maryland counties will owe approximately $200,000,000 in refunds and lose roughly $42,000,000 annually as a result of Wynne.

So, how did the Supreme Court reach its decision in Wynne? The majority opinion, authored by Justice Alito, recites the four factors that the Court has previously held must be satisfied for a state (or political subdivision) tax to avoid discriminating against interstate commerce in violation of the dormant Commerce Clause. Such a tax must: (1) be applied to an activity with a substantial nexus to the taxing state (or political subdivision); (2) be fairly apportioned; (3) be fairly related to the services provided by the taxing state (or political subdivision); and (4) not discriminate against interstate commerce. The factor at issue in Wynne was whether the county component of the Maryland income tax was fairly apportioned. The Court held that this tax was not fairly apportioned, because it was not “internally consistent” and would result in duplicative taxation of interstate commerce.

The apportionment of a state or local tax is internally consistent for purposes of the dormant Commerce Clause if it is assumed that all other jurisdictions have the same tax structure and, in this hypothetical world, interstate income is not taxed more than once. The county component of the Maryland income tax applies to all taxable income of a county resident, wherever derived, and it also applies to the taxable income derived from county sources by a nonresident. A county resident may not claim a credit against the county component of the Maryland income tax for income taxes paid to other states on the same income that is subject to the Maryland tax. Thus, if every jurisdiction had this same income tax structure, interstate income would be subject to double taxation – first by the jurisdiction in which the income is earned and then by the jurisdiction in which the recipient of the income resides. The Court held that the lack of internal consistency caused the county component of the Maryland income tax to be unfairly apportioned and to act as a disincentive to earning interstate income, all in violation of the dormant Commerce Clause.

Justices Scalia and Thomas each wrote separate dissenting opinions to state their respective opposition to the dormant Commerce Clause doctrine. Justice Ginsburg’s dissent, which was joined by Justices Kagan and Scalia, did not dispute the validity of the dormant Commerce Clause, but it raised a number of objections to the majority’s application of that doctrine. A primary contention asserted by Justice Ginsburg (and that was also noted by Justice Scalia in his separate dissent) is that the Court should have adhered to the view set forth in Goldberg v. Sweet, 488 U.S. 252, 266 (1989), and not applied the dormant Commerce Clause to the tax structure at issue in Wynne. The Court observed in Goldberg that “it is not the purpose of the Commerce Clause to protect state residents from their own state taxes” because residents, unlike those who do not reside in the state, can object to these taxes and effect change to the state tax system through the electoral process. Thus, Justice Ginsburg would have left undisturbed, without an application of the dormant Commerce Clause, the Court’s prior conclusion that, under the Constitution’s Due Process Clause, a state (or political subdivision of a state) may tax all the income of a resident, wherever earned.

The majority opinion in Wynne dismissed the Court’s statement in Goldberg as dictum that was at odds with prior precedent. The Court is not bound by what it characterizes as its prior dicta, and it would have sufficed for the majority opinion in Wynne to have left its dismissal of Goldberg v. Sweet at that. The majority opinion, however, espoused some gratuitous, and regrettable, dictum on this point. The majority opinion rejected as “fanciful” the notion that residents aggrieved by a tax structure like the one at issue in Wynne could obtain relief through the electoral process, because “it is likely that only a distinct minority of a State’s residents earns income out of State” and that such residents would therefore be outnumbered in any election.

In response, Justice Ginsburg observed in her dissent that when states first began to enact income taxes, many of them did not grant a credit to their residents for income taxes paid to other states and “that the very political processes the Court disregards as ‘fanciful’ have in fact worked” to result in the uniform grant of such credits by states that levy an income tax. She cites this in support of adherence to the philosophy of Goldberg v. Sweet and “to resist this Court’s heavy-handed supervision” of tax structures like the one at issue in Wynne. Had she wished to pile on, Justice Ginsburg could also have noted the success obtained by the distinct minorities that are subject to federal and state estate taxes and the top marginal federal and state income tax rates in lobbying for legislation that reduces these tax burdens. These minorities have succeeded in temporarily repealing the federal estate tax and, upon its reinstatement, significantly increasing the amounts that are exempt from that tax. They have also garnered the repeal of the estate tax in many states, and they have generally enjoyed over the last 35 years a significant reduction in the top marginal federal income tax rates and state income tax rates. The majority that has supported these reforms benefits only indirectly, if at all, from them. These reforms have prevailed through the electoral process notwithstanding that those who benefit directly from them are a distinct minority of any population. The disparagement of the electoral process by the majority opinion in Wynne is not only gratuitous and regrettable, it is demonstrably wrong and the height of judicial arrogance.

Regardless of whether the Court correctly applied the dormant Commerce Clause in Wynne, the decision is now the law (absent a very unlikely intervention by Congress, which has plenary power under the Commerce Clause), and, as noted above, it will work to the financial detriment of the many state political subdivisions that have income tax structures like the county income tax component of the Maryland income tax. Residents of such political subdivisions who were not granted an income tax credit should not yet, however, count their refunds or plan on obtaining credits in future tax years. A tax structure like the one at issue in Wynne would be “internally consistent” and not discourage interstate commerce if nonresidents were not subject to the given jurisdiction’s income tax. Thus, political subdivisions that have relatively few nonresident taxpayers but many resident taxpayers with interstate income could comply with Wynne by granting refunds to the nonresident taxpayers and excusing nonresidents from the income tax in the future.

Finally, it must be noted that I predicted in the earlier post on Wynne that a majority consisting of at least Justices Ginsberg, Kagan, Scalia, Sotomayer, and Thomas would uphold the structure of the county income tax component of the Maryland income tax. Justice Sotomayer, a native of the Bronx, decided against her hometown’s interests and stymied my prediction. I did, however, also predict that if the taxpayers prevailed in Wynne, we would at least be treated to one of the sharply worded dissents for which Justice Scalia is well known. I nailed that one.

ARTICLE BY Michael A. Cullers of Squire Patton Boggs (US) LLP

On May 18, the U.S. Supreme Court issued its decision inComptroller of the Treasury of Maryland v. Wynne. In short, the Court, in a five-to-four decision written by Justice Alito, handed the taxpayer a victory by holding that the county income tax portion of Maryland’s personal income tax scheme violated the dormant U.S. Constitution’s Commerce Clause.

Specifically, the Court concluded that the county income tax imposed under Maryland law failed the internal consistency test under the dormant Commerce Clause, because it is imposed on both residents and non-residents with Maryland residents not getting a credit against that Maryland local tax for income taxes paid to other jurisdictions (residents are given a credit against the Maryland state income tax for taxes paid to other jurisdictions).

The Supreme Court emphatically held (as emphatically as the Court can be in a five-to-four decision) that the dormant Commerce Clause’s internal consistency test applies to individual income taxes. The Court’s holding does create a perilous situation for any state or local income taxes that either do not provide a credit for taxes paid to other jurisdictions or limit the scope of such a credit in some way.

The internal consistency test—one of the methods used by the Supreme Court to examine whether a state tax imposition discriminates against interstate commerce in violation of the dormant Commerce Clause—starts by assuming that every state has the same tax structure as the state with the tax at issue. If that hypothetical scenario places interstate commerce at a disadvantage compared to intrastate commerce by imposing a risk of multiple taxation, then the tax fails the internal consistency test and is unconstitutional.

Although the Wynne decision does not address the validity of other taxes beyond the Maryland county personal income tax, the decision does create significant doubt as to the validity of certain other state and local taxes such as the New York State personal income tax in the way it defines “resident.” New York State imposes its income tax on residents on all of their income and on non-residents on their income earned in the state; this is similar to the Maryland county income tax at issue in Wynne.

“Resident” is defined as either a domiciliary of New York or a person who is not a domiciliary of New York but has a permanent place of abode in New York and spends more than 183 days in New York during the tax year. N.Y. Tax Law § 605. (New York City has a comparable definition of resident.) N.Y.C. Administrative Code § 11-1705. Thus a person may be taxed as a statutory resident solely because they maintain living quarters in the state and spend more than 183 days in the state, even if those days have absolutely nothing to do with the living quarters; this category of non-domiciliary resident is commonly referred to a “statutory resident.” As such, under New York’s tax scheme, a person can be a resident of two states—where domiciled and where a statutory resident—and thus be subject to taxation on all of their income in both states.

Although New York State grants a credit to residents for taxes paid to another jurisdiction, that credit is only for taxes paid “upon income derived” from those other jurisdictions. N.Y. Tax Law § 620. As such, New York State does not grant a credit for taxes paid to another jurisdiction on income earned from intangible property, such as stocks, because income earned from intangible property is not ‘derived from’ any specific jurisdiction.

To illustrate using an example, suppose an investment banker is unquestionably a domiciliary of New Jersey and has an apartment, i.e., permanent place of abode, in New York that he uses only occasionally. Further, suppose that the investment banker spends more than 183 days in New York during a tax year by going to his office in New York on most workdays. In such a case, the investment banker is a resident of both New Jersey and New York and subject to tax as a resident in both states on his entire worldwide income. New York does not give a credit for taxes paid to New Jersey on income derived from intangible property, and thus the investment banker pays tax on this income twice, once to New Jersey and once to New York, clearly disadvantaging interstate commerce and resulting in double taxation.

This is not some hypothetical example. This is actually the fact pattern in In the Matter of John Tamagni v. Tax Appeals Tribunal of the State of New York, 91 N.Y.2d 530 (1998). In that case, the New York Court of Appeals (New York State’s highest court) held that New York State’s taxing scheme did not violate the dormant Commerce Clause and did not fail the internal consistency test. The validity of the Court of Appeals’ decision is seriously called into question under the Wynne case.

The Court of Appeals, relying upon Goldberg v. Sweet, held that the dormant Commerce Clause did not apply to residency-based taxes because those taxes were not taxing commerce, but rather a person’s status as a resident. However, the U.S. Supreme Court’s decision in Wynne not only repudiates the very dicta from Goldberg v. Sweet cited by the New York Court of Appeals in Tamagni, but the U.S. Supreme Court also determined that even if a state has the power to impose tax on the full amount of a resident’s income, “the fact that a State has the jurisdictional power to impose a tax [under the Due Process clause of the Constitution] says nothing about whether that tax violates the Commerce Clause.” After Wynne, it is clear that the dormant Commerce Clause applies to residency-based personal income taxes.

The second reason that the vitality of the Tamagni decision is in question is its application of the internal consistency test. The Court of Appeals held that even if the dormant Commerce Clause applied, the internal consistency test was not violated because the tax at issue was imposed upon a purely local activity and thus could not violate the Complete Auto tests. However, as discussed above, New York State’s lack of a credit for taxes paid to other jurisdictions mirrors the lack of a credit under Maryland’s county income tax scheme.

New York State taxpayers should be cognizant of the Wynnedecision and should consider filing refund claims if they have paid— or will pay—tax to New York State as a statutory resident (i.e., not as a New York domiciliary). One would expect the New York State Department of Taxation and Finance to be quite resistant to granting such refunds and likely to vigorously defend the existing taxing scheme.

It may be worthwhile to note that this problem of double taxation was acknowledged and addressed in an agreement executed in October 1996 by the heads of the revenue agencies of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. Under that agreement, the “statutory resident” state would provide a credit for the taxes paid by the individual on his or her investment income to his/her state of domicile. Unfortunately, that agreement was never implemented through legislation— maybe now is the time for that to be done.

Finally, a word about New York City: New York City imposes a personal income tax on residents, allowing no credit for taxes paid to other jurisdictions. However, New York City does not impose a tax on non-residents, making its personal income tax different than the Maryland county income tax. Thus, the constitutionality of the New York City personal income tax is not specifically addressed by the U.S. Supreme Court’s decision. However, similar to the New York State definition of resident, a person can be a resident in two different jurisdictions under the New York City definition of resident. As such, New York City’s personal income tax could be imposed twice on a person if the person is a domiciliary of one state and a statutory resident in another. Thus, the tax potentially fails the internal consistency test.

ARTICLE BY

Arthur R. Rosen & Mark Yopp of McDermott Will & Emery

Tag: Dormant Commerce Clause

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