Corporate Close-Up: Will Pass-Through Entity Owners Get Full Credit for Taxes Paid to Other States?

On Wednesday, Nov. 12, the U.S. Supreme Court will hear the oral arguments in Maryland State Comptroller v. Wynne, in which the Maryland Comptroller is seeking to overturn a Maryland high court decision that the state’s system of credits for taxes paid on foreign income to other states is unconstitutional.

The case also has large implications for the business community in the U.S. Ninety percent of business entities in the U.S. operate as S corporations, partnerships, or sole proprietorships. Should the court reverse the Court of Appeals’ ruling, these types of entities could be taxed twice on the same income in different jurisdictions. The application of the Dormant Commerce Clause to pass-through entities and the ensuing effect on interstate commerce are at the center of this case.

The case turns on the income that Brian Wynne and his wife Karen Wynne reported in 2006 as shareholders in Maxim Healthcare. Maxim is an S corporation, meaning that it is not taxed at the entity level on its income, but rather passes it through to its shareholders proportionately, who then are taxed on that income. In 2006, Maxim did business in 39 other states aside from Maryland, which all assessed their own taxes on that income based on how much was earned within their borders.

The Wynnes reside in Maryland, which imposes taxes at both the state and county level on the income of its residents. Maryland offers tax credits at the state level for taxes paid on income in other states. However, the state does not offer credits against the county income tax, also administered under state law. The Wynnes have argued that this is an unconstitutional restraint of interstate commerce.

As shareholders in an S corporation that operates in many different states, the Wynnes wish to avoid double taxation on their income from multiple jurisdictions. Their argument is that the failure of Maryland to also allow a credit against the county income tax for taxes paid in other states on income is a violation of the Dormant Commerce Clause because it discourages shareholders of S corporations from doing business across state lines. The Wynnes were successful in the Maryland Court of Appeals, and the Maryland Comptroller has appealed to the U.S. Supreme Court.

The Comptroller has argued that the tax credits offered to offset taxes paid on income in other states are a matter of legislative grace. It posits that state sovereignty dictates that no state should have to tailor its tax policy to accommodate the taxation structures of other states, and that to force a dollar for dollar credit would be a violation of that sovereignty. It argues that U.S. Supreme Court jurisprudence has dictated that states are free to tax the entire income of their residents as they see fit.

Both sides have had several amici supporting their filings in this case, many of which envision several worst case scenarios should the opposing side win. Proponents of the Wynnes argue that allowing the Maryland tax structure of credits to stay in place will have a chilling effect on interstate commerce and allow other states to follow suit. Proponents of the Comptroller argue that a victory for the Wynnes would open up a flood of litigation in other states where taxpayers may challenge any credit that does not fit exactly the dollar for dollar credit system seemingly required by the lower courts’ decisions. Further BBNA analysis of the amici briefs can be found here.  

Briefs for the case can be found at:

By Alex Dowd

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