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Supreme Court Decision May Present a Refund Opportunity

Wayne Berkowitz, CPA, J.D., LL.M. 05.28.2015 | Client Alert

New York City resident taxpayers may have a refund opportunity, thanks to a recent U.S. Supreme Court decision striking down the current structure of the Maryland credit for income taxes paid to other states. 1

Action

New York City residents and residents of other jurisdictions with a local component to the income tax should discuss protective refund claims with their advisors to determine whether a material tax credit would be forthcoming were the credit mechanisms deemed similar to Maryland's.

The protective refund claims will preserve the statute of limitations while state tax authorities evaluate the decision in order to determine its implications on these similar resident credit schemes. 

Maryland residents should consult with their advisors to determine whether filing Maryland refund claims may result in additional resident credits.

How the Credit Works

State residents pay tax on all income earned regardless of the source.  A state where a taxpayer is not a resident is permitted to impose a tax on income sourced to his or her state from business and other activities (such as real estate) located in his or her jurisdiction.

To prevent income from being taxed twice, a taxpayer's resident state is required to provide a credit for income sourced and correspondingly taxed in the nonresident state.  While the credit system never works perfectly, taxpayers are often made whole and will end up paying no more than what the total resident tax liability would have been.

Example:

A New York State resident earns $5 million and is subject to tax at the State's highest marginal rate of 8.82%.  The $5 million is earned entirely from real property located in Colorado, and accordingly, the taxpayer must file a nonresident return in Colorado and pay tax at the rate of 4.63%.  Since Colorado's rate is lower than the New York rate, all else being equal (ignoring differences for the computation of income, itemized deductions, etc.) the taxpayer will get a credit from New York, his resident state, for the entire tax paid to Colorado.  The total tax bill paid to the two states will not exceed the total New York liability before credits.

However, things get more complicated when the nonresident state has a higher tax rate than New York.   If the facts were identical, except we move the real property to New Jersey, where the top rate is currently 8.97%, the resident credit doesn't wholly compensate the New York resident.  He or she will be required to pay New Jersey tax at 8.97%, but the credit will never exceed the amount paid to New York State.  This is permissible as the credit is only required to ensure the taxpayer isn't taxed twice, not to compensate for another jurisdiction's higher rate.

So where did the Supreme Court find a problem in the credit mechanism?  Let's take the same example once more, but this time the taxpayer is a resident of New York State as well as New York City.  The combined top rate is 12.696%.  Once again, the property is in New Jersey and the income is taxed at 8.97%.  In this scenario, New York State (as was the case in Maryland) only permits the New Jersey tax paid to be credited against the State component of the tax (the 8.82%).  Despite the fact that the taxpayer's combined rate between State and City is over 12%, a credit is not permitted for the New Jersey tax paid in excess of the New York State tax rate.

The Court's Decision

The Maryland credit, like New York City and several other jurisdictions with a local tax component, doesn't allow a resident credit against the local component.  The Supreme Court essentially held that this is a distinction without a difference as the locality, at least in the case of the County tax in Maryland, is no different than the State and by not allowing a credit against that component, subjected the same income to tax twice.

Questions? Contact your Berdon advisor or Wayne Berkowitz, CPA, J.D., LL.M. at 212.331.7465 | wberkowitz@berdonllp.com.

1 Comptroller of the Treasury of Maryland v. Wynne et ux. Certiorari to the Court of Appeals of Maryland No. 13-485. Argued November 12, 2014. Decided May 18, 2015. 
 

 

 

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