Welcome back to Legal Geek. This week, we answer a listener question from James regarding a recent Supreme Court case on interstate commerce and fairness in taxation.
James asked about why the Supreme Court deemed that double taxation on personal income is not OK under the dormant commerce clause in a recent decision, while internet use tax is acceptable. The case James refers to is Comptroller of Maryland vs. Wynne.
To briefly summarize, the Wynnes work in a different state and live in Maryland. Maryland, like most states, collect income tax from residents of Maryland who work there or in other states, and also from non-residents who work in Maryland. But unlike most states, Maryland did not provide a tax credit or reduction for income taxes paid by residents who work in other states and have the typical income tax collected by those other states. This means residents of Maryland working outside the state ended up paying income tax twice, to Maryland as well to as the state of employment. This was challenged as unconstitutional.
The Supreme Court ruled in a split 5-4 decision that Maryland's lack of a tax credit to avoid such double taxation was unconstitutional under the dormant commerce clause. The dormant commerce clause is an interpretation of the interstate commerce clause and allows courts to bar states from passing legislation that improperly burdens or discriminates against interstate commerce. Essentially, the majority in the Court deems that this state tax policy is an improper burden on interstate commerce because it hampers the ability of Maryland citizens to work in other states.
Despite the close decision, we will assume that the controlling legal theory is now that unbalanced income tax laws are improper. Which brings us to James's question: why is the similar unbalance in state use tax laws permissible?
Use taxes are assessed upon tangible personal property purchased by a resident of the assessing state for use, storage or consumption in that state, regardless of where the purchase took place, including online. This is a way for states to make up for lost sales and sales taxes within their state, especially in the modern era of heavy internet commerce.
On its surface, this type of tax policy looks unfavorable to residents in a similar way as the Maryland income tax law was for the Wynnes. Indeed, the recent Supreme Court decision could potentially apply to use taxes as well. But one key difference from double income taxes is that use taxes applied to out-of-state purchases is arguably not discriminatory against interstate commerce, but instead, evenhanded by making all sales to residents within a state subject to the same level of tax.
In addition, in rare circumstances where a sales tax is collected by an out of state business shipping to a customer in another state, the customer's state generally allows a tax credit to reduce use taxes by this sales tax paid to the other state. Thus, there does not appear to be a true double taxation problem in the sales and use tax context. Quite frankly, that could be the type of factual situation needed to prompt Congressional or judiciary action under the commerce clause.
Bottom Line: although the dormant commerce clause may someday be used to help better regulate sales and use taxes, for now, the generally evenhanded nature of these taxes when taken in combination probably protects them from constitutional scrutiny, so long as states don't make the mistake of disallowing tax credits for the rare sales tax collected on out-of-state transactions. In all other respects, any inequality is simply the same as states which charge different income tax rates, which has not been deemed a violation of the dormant commerce clause either, for what it's worth.
Thanks James for your thought-provoking question!
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