On January 28, 2013, the Court of Appeals of Maryland, the State’s highest court, ruled that the failure of the Maryland income tax law to allow a credit against the county tax for a Maryland resident taxpayer with respect to pass-through income of an S corporation that arises from activities in another state and that is taxed in that state violated the Constitution’s Commerce Clause. Md. State Comptroller v. Wynne (Md., Jan. 28, 2013).
Under both federal and Maryland state law, a sole proprietorship, a partnership, a limited liability company or a Subchapter S corporation is deemed to “pass through” its income to its owners, partners, members or shareholders who are taxed on that income at the individual’s level. The Maryland income tax law imposes both “state income tax” and “county income tax” on all of the income of a Maryland resident, whether derived within or outside of Maryland. Maryland allows residents to reduce their state income tax based on taxes paid to another state. However, Maryland did not allow its residents to reduce the county income tax based on the taxes paid to another state.
The Court in Wynne found that Maryland’s allowance of a credit to the “state income tax” and not the “county income tax” is unconstitutional. This is because it results in a significant different treatment for a Maryland resident taxpayer who earns substantial income from out-of-state activities when compared with an otherwise identical taxpayer who drives income exclusively from Maryland business activities. Such tax schemes create a double taxation through the application of the county tax on the first taxpayer.
After the Court’s decision, Maryland business owners who have taxable income from sources in other states (especially from high-tax jurisdictions like New York, New Jersey, Massachusetts, and California) may pay less in total state and county income taxes. Those that have paid income taxes to other states may consider amending their previous Maryland income tax returns.
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In accordance with IRS requirements, we wish to inform you that, to the extent this communication contains tax advice, it is not intended or written to be used for the purpose of 1) avoiding tax penalties that may be imposed on the taxpayer by the Internal Revenue Service, or 2) promoting, marketing or recommending to another party any transaction or matter addressed herein.