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Background

  • A number of states clustered in the Midwest and Maryland have county income taxes. These include
    Indiana, Kentucky, Ohio, and Pennsylvania.
  • Certain large cities impose income taxes on residents, and on non-residents with sourced within the city.
    These include Newark, New York, Philadelphia, and San Francisco.
  • Most states tax all of the income of residents, regardless of where earned, and regardless of whether that
    income is also taxed by another state.
  • When two states tax an item of income, resident states allows tax credits on the income up to the tax rate
    of the other state taxing the income.
  • Maryland refused to consider the local taxes levied in other states in the computation of the amount of
    tax eligible for the credit. Maryland also did not allow Maryland local taxes to be factored into the credit
    limitations.

Example #1

Maryland resident with a 5.75% state income tax rate and a 3% local income tax rate.

Ohio source income taxed at 4% state income tax rate and a 2% local income tax rate.

Assuming $100,000 of Ohio source income, Maryland allowed a $4,000 tax credit on the residents’ Maryland
income tax return (4% * $100,000). The 2% local tax was ignored.

Example #2

Maryland resident with a 5.75% state income tax rate and a 3% local income tax rate.

California Source income with a 13% state income tax rate and a 1% local rate.

Assuming $100,000 of California source income, Maryland allows a $5,750 tax credit on the residents’
Maryland income tax return ($100,000 * 5.75%).

  • Taxpayers challenged this treatment, and the case went to the U.S. Supreme Court. (Comptroller of
    Treasury of Maryland v. Wynne)

Analysis

Maryland’s approach was to draw an artificial distinction between state and local taxes in the credit calculations.
This resulted in double taxation of income because the effective income tax rates of both the home state and the
nonresident state were understated.

In Example #1, if both state and local income taxes were considered, the Maryland tax credit would have been
$6,000. The effective Ohio income tax rate is 6%. Since this is less than the 8.75% Maryland rate, the full
amount of tax paid to Ohio is credited.

In Example #2, if both state and location income taxes were considered, the Maryland tax credit would have
been $8,750. The effective California rate is 14%. Since this is greater than the 8.75% Maryland rate, the credit
is limited to the Maryland tax on the income.

U.S. Supreme Court Ruling

Maryland’s disallowance of local taxes in tax credit calculations was determined to be illegal because it
operated as a tariff and discriminated against interstate commerce.

Taxpayers will be less interested in the logic of the ruling than its effect. Maryland officials estimated that the
state would lose $45 million to $50 million annually, and might have to refund up to $120 million previously
collected. A smackdown indeed. The Supreme Court ruling will allow taxpayers to amend returns for open
years.

Action for Taxpayers

Taxpayers who had income in multiple states and paid local income taxes should re-review tax credit
calculations for open years (2012, 2013, and 2014).