If you have ever earned income in another state, you may have been unpleasantly surprised when your tax adviser informed you that you owed taxes to two states – to the state where the income was earned and to your state of residency. What?! How can this double taxation be?
The concept of double taxation seems unfair to taxpayers and in most cases, the situation is resolved by State #1 giving you a tax credit for the taxes paid to State #2. My state of residency, Arizona, gives you a tax credit for taxes paid to 40 other states and taxes paid to foreign countries.
However, some states also have “county” and “city” income taxes and have not allowed its residents to claim a credit on their resident tax return for taxes paid to another state.
In May, the United States Supreme Court ruled that Maryland cannot impose double taxation on residents by denying them a full credit for certain taxes paid on income earned in other states.
In a 5-4 ruling, the justices sided with taxpayers Brian and Karen Wynne in finding that Maryland’s taxation policy violated the U.S. Constitution by discriminating against interstate commerce, upholding lower-court decisions favoring the couple.
Maryland offers a tax credit for income taxes paid by residents to other states. But it said the credits available to the Wynnes for their out-of-state income did not apply to the couple’s county income tax.
The Wynnes were denied the full $84,550 tax credit they sought based on their healthcare business that paid taxes in 39 states in 2006. Maryland said they owed around $25,000.
The Supreme Court ruling could reduce tax revenues collected by local jurisdictions in Maryland by up to $50 million a year, according to a brief filed by the U.S. Conference of Mayors and other groups that backed the state.
New York City, Detroit and Philadelphia are among the other cities that impose income taxes and do not provide a full credit for taxes paid out of state.
It remains to be seen how these governments will respond to the new Supreme Court ruling and the many applications for tax refunds that are sure to come!
By Melinda Nelson, CPA