Correction: Earlier version of this article incorrectly said the ruling applied only to shareholders of certain small businesses. The ruling applies to all Marylanders who pay income tax out of state.
A divided Supreme Court ruled Monday that Maryland’s income tax law is unconstitutional because it does not provide a full tax credit to residents for income tax paid outside the state, a ruling likely to cost Maryland counties and localities across the country millions of dollars in revenue.
The court voted 5 to 4 to affirm a 2013 Maryland Court of Appeals ruling that the state’s practice of withholding a credit on the county segment of the state income tax wrongly exposes some residents with out-of-state income to double taxation. Justices said the provision violated the Constitution’s commerce clause because it might discourage individuals from doing business across state lines.
In most states, income from elsewhere is taxed both where the money is made and where taxpayers live. To guard against double taxation, states usually give residents a full credit for income taxes paid on out-of-state earnings.
Maryland residents are permitted to deduct income taxes paid to other states from what they pay in Maryland income tax. But the state did not allow the same deduction to be applied to a “piggyback” tax that is collected by the state for counties and the city of Baltimore.
The ruling affects about 55,000 Maryland taxpayers, according to the state comptroller’s office.
Those who tried to claim the credit on their county income tax returns between 2006 and 2014 are likely to be eligible for refunds, which officials estimate could total $200 million with interest.
Going forward, certain small-business owners who pay income taxes to another state on income earned in that state will be able to claim a credit for both the state and county portions of the Maryland tax, costing Maryland an estimated $42 million a year in revenue.
Montgomery County, which has the highest share of residents with out-of-state income, stands to be hardest hit. State officials estimate that the county is on the hook for about $115 million in refunds and interest, plus a loss of $24 million a year in tax revenue.
“I was hoping we would avoid this,” said County Executive Isiah Leggett (D), warning that the loss of revenue increases the likelihood of a major property tax increase next year. “This case cannot be overstated in terms of its significance.”
The ruling in Comptroller of the Treasury of Maryland v. Wynne also potentially affects thousands of other cities, counties and states with similar tax laws, including New York, Indiana, Pennsylvania and New York.
The case was brought by a Howard County couple, Brian and Karen Wynne, who reported $2.7 million in 2006 income, about half from their stake in Maxim Healthcare Services, a Columbia-based home-care and medical staffing company that does business in more than three dozen states.
The Wynnes paid $123,363 in Maryland state income tax and claimed an $84,550 Maryland credit for taxes paid in other states on income from Maxim.
Maryland taxes personal income at up to 5.75 percent. It also collects and distributes a piggyback income tax of up to 3.2 percent for each of the 23 counties and Baltimore City. But Maryland until now has offered no credit for the piggyback tax — in this case, the 3.2 percent the Wynnes owed to Howard County. The Wynnes and their attorneys contended that this represented about $25,000 in illegal double taxation.
The court was sharply divided, although not along the usual ideological lines. Justice Samuel A. Alito Jr. wrote the opinion for a majority that comprised him, Chief Justice John G. Roberts Jr. and Justices Anthony M. Kennedy, Stephen G. Breyer and Sonia Sotomayor.
Alito said the court has long recognized that the commerce clause has a “dormant” or underlying meaning. This holds that while the clause gives Congress the power to regulate commerce among the states, it also was intended to ensure that states would not pass laws to restrict interstate business.
Maryland’s tax law violates that implicit aspect of the commerce clause, Alito said.
State officials argued that under the due process clause of the Constitution, states have a historic right to tax the income of their residents, no matter where it is earned.
The piggyback segment is excluded from the tax credit, officials said, to ensure that all residents pay an equitable share for local government services such as schools and public safety.
But Alito said Maryland’s argument is flawed because states have long offered a similar credit for out-of-state taxes paid by corporations, who “also benefit heavily from state and local services.”
Alito called Maryland’s tax policy “inherently discriminatory,” saying it essentially operates as a tariff, or a tax designed to restrict trade.
Justices Ruth Bader Ginsburg, Antonin Scalia, Elena Kagan and Clarence Thomas dissented, with Ginsburg, Scalia and Thomas writing separate opinions.
Ginsburg, writing the principal dissent, said there was nothing in the Constitution that compelled Maryland — or any other state — to change its laws because of taxes paid by its residents elsewhere. .
In his dissent, Scalia called the dormant commerce clause “a judge-invented rule under which judges may set aside state laws that they think impose too much of a burden upon interstate commerce.” Scalia said he agreed that such a view of the clause has a long history. “So it does, like many weeds,” he wrote. “But age alone does not make up for brazen invention.”
Brian Wynne, who now lives in Carroll County and no longer works for Maxim, declined to comment Monday.
Michelle Parker, a spokeswoman for Comptroller Peter Franchot (D), said in a statement Monday that the office will “work diligently and in a timely manner to comply with the decision and enforce Maryland law consistent with the decision of the Supreme Court.” Parker added that the office is already reviewing about 8,000 refund claims dating back tjo 2006.
Money for the refunds will come from the state’s income tax reserve fund. The state will recoup that money by reducing state income tax revenue sent to localities each quarter over a period of two years, starting in June 2016.
Maryland’s General Assembly last year lowered the interest rate that applies to refunds from past years in order to cushion the blow in case the Supreme Court ruled against the state. The interest rate was reduced from 13 percent to the average prime rate during fiscal 2015, or about 3 percent.
Josh Hicks contributed to this report.