Maryland overtaxed a portion of out-of-state income earned by its residents, and must now refund hundreds of millions of dollars, the Supreme Court ruled Monday in a decision that could have a significant impact on city and county budgets.
In the 5-4 ruling, the court found that the way the state taxes income earned beyond its borders is unconstitutional, because it discourages interstate commerce. The decision upheld a 2013 ruling by the Maryland Court of Appeals.
The decision could lead to refunds for an estimated 55,000 taxpayers in Maryland, and affect similar laws in New York, Pennsylvania, Indiana and Ohio.
At the same time, it will cost Baltimore and the state’s counties tens of millions of dollars annually in lost revenue.
“Maryland's tax scheme is inherently discriminatory and operates as a tariff,” Justice Samuel Alito wrote for the court. “Maryland's tax unconstitutionally discriminates against interstate commerce, and it is thus invalid regardless of how much a particular taxpayer must pay to the taxing state.”
The suit was filed by Brian and Karen Wynne, a Howard County couple who said they should have received a credit for income they earned — and on which they paid taxes — in other states. Brian Wynne received earnings from a partial ownership of a health care company that operates in multiple states.
Such a credit can be claimed against state income tax in Maryland, but not on the “piggyback” taxes that are used to pay for county services.
The state comptroller’s office estimates nearly 8,000 claims have already been filed for refunds worth more than $200 million. With the ruling Monday, that number is likely to increase significantly.
A statute of limitations will limit refund claims to three tax years.
In addition to being on the hook for refunds, counties will lose an estimated $42 million annually once tax collections are adjusted to reflect the court’s decision.
Officials in several jurisdictions said they had anticipated the possibility of the decision, and had planned accordingly.
Officials in Baltimore established a $4.2 million reserve early in the litigation to cover the estimated cost of reimbursing city taxpayers. Going forward, officials expect to lose about $1.4 million in revenue annually.
“This decision will obviously cost the city some revenue which will require some difficult choices be made down the road,” said Kevin Harris a spokesman for Baltimore Mayor Stephanie Rawlings-Blake. “However, the mayor thought it was important that the city be proactive and plan ahead [and] funds were set aside to cover potential loss of revenue.”
Leslie Knapp Jr., legal and policy counsel for the Maryland Association of Counties, said the decision will require jurisdictions to “have to adjust to a relatively large annual hit to their revenue.”
Montgomery County will take the largest hit, according to estimates from the comptroller's office and county officials, at just over $24 million per year — more than half the statewide total.
When the cost of reimbursing taxpaers is added to lost revenue, Montgomery County Executive Isiah “Ike” Leggett said Monday, the impact in fiscal year 2017 could exceed $50 million.
“As we have done in the past, we will continue to work closely with the council to jointly and comprehensively address this challenge to maintain the county’s strong financial position going into the future and ensure the continuity of essential services,” Leggett wrote in a memo to members of the County Council.
The next largest losses would fall in Baltimore County, at $4.5 million, and Anne Arundel County, at $3.6 million, according to state estimates.
A spokeswoman for Baltimore County described it as “a significant cut” that would “necessitate some difficult choices in the future.”
Spokeswoman Ellen Kobler said it is too soon to identify what those choices may be.
“This is yet another reminder of why Baltimore County fights attempts in Annapolis to reduce its revenues,” she said in a statement. “It is also affirmation of the county’s history of maintaining an adequate fund balance.”
A spokesman for Anne Arundel County said officials there assumed the court would side with the Wynnes, and that there would be a “minimal impact” this year.
“Going forward, the county will owe some re-reimbursements that will need to be paid over the next few years, and we will make those decisions as the fiscal picture during next year's budget cycle becomes more clear,” spokesman Owen P. McEvoy said.
The case centered on the unusual way income earned in other states is treated by Maryland.
States that levy an income tax typically offer credits for income taxes paid to other states. But Maryland collects both a state tax and a county tax, and treats credits for the two differently.
Residents can claim credits for income tax paid to other states only against the portion used to fund the state budget — but not the part reserved for local governments.
The Wynnes challenged that distinction in their 2006 tax bill. Their attorneys argued that the state's credit rules led to some of their income being taxed twice, in violation of the Constitution.
Brian Wynne “believes that the court has reached a just and fair conclusion,” Neal Katyal, an attorney who represents the family said in a statement. “And he further believes that the decision will provide an enhancement to future Maryland residents who desire to operate in interstate commerce.”
In dissent, Justice Ruth Bader Ginsburg said nothing in the Constitution requires a state to avoid taxing its residents just because another state has a similar tax regime targeting the same income. She was joined in dissent by Justices Antonin Scalia and Elena Kagan.
Joe Henchman, vice president for legal projects at the Tax Foundation, a conservative think tank based in Washington, said the decision could jeopardize tax laws in other states.
That includes telecommuter taxes that New York and some other states impose on people who work from home. These workers also face double taxation on income by their home state and the state in which their employer is located, he said.
“Any law that is justified by the idea that `We're going to tax the out-of-staters more heavily than in-staters,' those laws should now be evaluated very closely to see their harms on interstate commerce,” he said.