Maryland prepares for $200 million hit from Supreme Court tax case

Maryland officials are bracing for a Supreme Court decision this spring that could find a provision of the state’s income tax law unconstitutional, leaving the state and its counties on the hook for as much as $200 million in refunds and facing significant cuts in revenue.

Montgomery County stands to be hit hardest if the court rules against the state in Comptroller of the Treasury of Maryland v. Wynne . The decision, expected as soon as next week, could also trigger changes in state and local tax laws nationwide.

The case was brought by a Howard County couple challenging a provision in state law that denies residents a full credit for taxes paid on income earned outside the state.

Most states extend the full credit. But Maryland law bars a credit on the “piggyback” segment of its state income tax. This is revenue collected by the state and distributed to the 23 counties and Baltimore City. Localities set the rates, up to a 3.2 percent maximum.

The Howard couple, Brian and Karen Wynne, reported $2.7 million in income for 2006, about half from their stake in Maxim Healthcare Services, a Columbia-based home health-care and medical staffing company that does business in more than three dozen states. The Wynnes paid $123,000 in Maryland income tax and received an $84,500 credit for taxes they paid in the other states.

But when the Wynnes’ claim for a credit against Howard County’s 3.2 percent income tax was denied, they filed suit. They contended that this amounted to illegal double taxation, forcing them to pay income tax in the state where the money was earned and again in the county where they live.

Maryland officials maintain that states have a historic right to tax the income of residents no matter where it is earned. They also contend that allowing a credit for the county income tax means that residents with big out-of-state incomes would pay less for schools, public safety and other local services than residents with largely in-state income.

The Maryland Court of Appeals decided in favor of the Wynnes, ruling in 2013 that withholding the credit violated the Commerce Clause of the Constitution because it might discourage corporations from doing business across state lines. Maryland appealed to the Supreme Court, which agreed to hear the case.

Wynne, who is no longer with Maxim, declined Friday to discuss the case in detail.

“It’s just double taxation, and I think it’s unfair,” he said.

If the Supreme Court reverses the Maryland Court of Appeals — deciding that states are not required to offer the full credit — it could send ripples through the tax systems in the more than 40 states that do. Legislatures scuffling to balance their budgets might view reducing or eliminating the credit as an attractive option.

“It would be a game-changer,” said tax attorney Jeff Friedman, who co-authored an amicus brief for the U.S. Chamber of Commerce in support of the Wynnes.

But if the lower court ruling is upheld, Maryland and its localities would take a one-two fiscal punch. They would owe an estimated $200 million in refunds and interest to taxpayers who, like the Wynnes, also filed claims in the past seven years for a credit on their county taxes. Going forward, the state probably would have to change its tax code to begin offering the credit against the county tax, producing a loss of about $42 million a year in revenue, according to estimates by the state comptroller’s office.

Lawmakers are expected to include language in the new state budget authorizing the comptroller to begin issuing refunds if the court rules against Maryland. The money would come from a reserve fund used by the comptroller’s office to pay refunds. Legislators are also likely to add a provision to offer the county tax credit going forward if the state loses the case.

To repay the fund, counties would have their quarterly tax revenue payments from the state reduced over a period of two years, starting in late 2016 or early 2017.

Montgomery County, the state’s wealthiest jurisdiction, stands to be hit hardest because of its large number of residents who earn out-of-state income. It would foot about half the bill: an estimated $115 million in refunds and interest, plus an annual revenue loss of about $24 million. Counties close to the Delaware line, where many residents live in Maryland but earn money across the border, would also be hit hard.

“It could be very costly,” said state Sen. Richard S. Madaleno Jr. (D-Montgomery), vice chairman of the budget and taxation committee. “You’re talking about a drop in income tax revenues that probably is in line with the worst year of the recession.”

Montgomery County Executive Isiah Leggett (D) said the impact would in some ways be worse than the recession.

“A recession, you can build your way out of,” Leggett said. “This is a permanent hit.” Concern over possible revenue loss from the Wynne case is one reason that a property tax increase next year is highly likely, he said.