The Supreme Court of the United States on Wednesday considered placing new limits on how states can assess income tax on money that residents earn across state lines.
Several justices appeared skeptical of a Maryland official who argued that the state's current system for taxing out-of-state earnings passes constitutional muster.
At issue is whether Maryland can tax income that has already been taxed in another state. Last year, Maryland's highest court said the tax system violates the Constitution's Commerce Clause because it discourages Maryland residents from earning money outside the state.
Other states are carefully watching the case, which could mean the loss of hundreds of millions of dollars in revenue if the court narrows the scope of tax collection.
Maryland currently lets residents deduct income taxes paid to other states from their Maryland state tax, but it does not apply the deduction to a local "piggy back" tax collected for counties and some city governments.
Maryland residents Brian and Karen Wynne say the scheme unfairly imposes a double tax burden on them. The couple challenged their Howard County, Maryland, tax bill in 2006, which blocked them from deducting $84,550 that they had paid in income taxes to 39 other states. Brian Wynne's out-of-state income resulted from his ownership stake in a health care company that operates in those states.
Chief Justice John Roberts, the only justice who lives in Maryland, said the scheme imposes a special tax on those who live in one state and work in another.
"That sounds unequal, whether fair or not," Roberts told Maryland Acting Solicitor William Brockman.
Justice Samuel Alito said the tax operates like an unlawful tariff that provides an incentive to earn income in Maryland and not outside the state.
"Why shouldn't this tax system meet exactly the same fate as a tariff," Alito asked.
Brockman said the law is even-handed in application and argued that the state has broad power to tax residents who take advantage of public schools, social service programs and other state benefits. He said there is no reason a state should have to subordinate this power just because another state taxes the same income.
Maryland officials say a ruling against them would affect more than 23 million Americans living in nearly 5,000 local jurisdictions that impose a personal income tax. That includes New York, Indiana, Pennsylvania and Ohio.
Justice Department attorney Eric Feigin, appearing for the Obama administration, argued in support of Maryland. He said there may be some cases in which a Maryland resident will be taxed more on earnings from outside the state, but asserted that's not Maryland's fault.
"It arises from the combination of the income taxes of two states," Feigin said.
Dominic Perella, attorney for the Maryland couple, insisted that the tax does operate like a tariff, which he called "the quintessential unlawful tax" under the Constitution.
What about a Maryland resident who earns all his money in another state, Justice Ruth Bader Ginsburg asked. Wouldn't it be unfair if he paid no taxes on that income to Maryland, yet had five children attending the state's public schools?
Perella said that may happen in rare cases, but he argued that it also happens in the other direction with out-of-state residents who earn all their income in Maryland.
A decision is expected by late June.