Over seven years after the United States Supreme Court issued its opinion in Comptroller of Maryland v. Wynne, 575 U.S. 542 (2015), the Pennsylvania Supreme Court is dealing with a very similar case involving the federal constitutional restrictions on state and local taxation. In Diane Zilka v. Tax Review Board City of Philadelphia, 20 and 21 EAP 2022, a case which is garnering national attention, the issue once again involves how out-of-state credits are treated in the face of restrictions required by the Commerce Clause of the United States Constitution. Despite the plain language of Wynne that requires state and local taxes to be viewed as a collective burden for purposes of constitutional analysis, the courts below in Zilka did not apply that standard. Due to the national importance of the issue involved, the American College of Tax Counsel [1] filed an amicus curiae brief, authored by the Troutman Pepper tax team, in support of the taxpayer.

Background

The facts of the case are straightforward. The taxpayer resided in Philadelphia, Pennsylvania ("Philadelphia") and worked in Wilmington, Delaware. During the years at issue, the taxpayer paid income taxes on the same income to two states and two local jurisdictions: Pennsylvania, Delaware, Wilmington and Philadelphia. She claimed the available credit for income taxes paid to Delaware against her Pennsylvania income taxes, which offset the full amount of her Pennsylvania state tax liability. Originally, she did not claim the "excess" Delaware state income tax credits against the local taxes she paid to Philadelphia. This resulted in some of her income being taxed twice which would not have happened had she only worked in Pennsylvania.

On April 9, 2017, the taxpayer filed a refund petition with the Philadelphia Department of Revenue seeking a refund of the Philadelphia City Wage Tax (the "Wage Tax") for the tax years at issue. In the refund petition, she claimed a credit against the Wage Tax for the income taxes paid to Wilmington and the income taxes paid to Delaware that weren't previously applied against her Pennsylvania liability. The Philadelphia Department of Revenue allowed her a credit for income taxes paid to Wilmington; however, it denied her a credit for income taxes paid to Delaware that exceeded her Pennsylvania state tax credit. The decision was upheld by the City of Philadelphia Tax Review Board, the Philadelphia Court of Common Pleas, and the Commonwealth Court.

As a result of the decisions by Philadelphia and the courts below, the taxpayer is paying more tax due to her interstate working arrangement versus a Philadelphia resident who works entirely intrastate. As a result, the scheme as applied by Philadelphia and upheld by the courts below violates the Commerce Clause.

The Commerce Clause

The United States Constitution imposes "an implicit restraint on state authority, even in the absence of a conflicting federal statute." United Haulers Assn., Inc. v. Oneida-Herkimer Solid Waste Management Authority, 550 U.S. 330, 338 (2007). This restraint stems from the Commerce Clause, which grants Congress the sole power "[t]o regulate Commerce with foreign Nations, and among the several States . . . ." U.S. Const. art. I, §8, cl. 3.

The Supreme Court has long held that under the Commerce Clause "interstate business…shall not be burdened with cumulative exactions which are not similarly laid on local business." Western Live Stock v. Bureau of Revenue, 303 U.S. 250, 258 (1938). The Supreme Court consistently has recognized the harm that multiple state taxes could inflict on interstate commerce, plainly holding that a state "may not tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State." Armco Inc. v. Hardesty, 467 U.S. 638, 642 (1984). The restrictions on taxation of interstate commerce imposed by the Commerce Clause follow from the framers' "conviction that in order to succeed the new Union would have to avoid the tendencies toward economic Balkanization that had plagued relations among the Colonies and later among the States under the Articles of Confederation." Hughes v. Oklahoma, 441 U.S. 322, 325-26 (1979).

By denying the taxpayer the full credit for Delaware state tax paid, she is subject to a higher tax burden than she would have been if she were a Philadelphia resident working wholly in Pennsylvania. This is an impermissible burden on her participation in interstate commerce.

Wynne

The Wynne opinion provides the roadmap for the proper analysis. In Wynne, the Supreme Court held that the Commerce Clause requires that credits for taxes paid to other states must be permitted to offset a local tax paid in a taxpayer's state of residence on the same income. Wynne, 575 U.S. at 564.

Wynne involved the Maryland state personal income tax and a county-level tax upon income. A married couple residing in Maryland received pass-through income from an "S" Corporation, which filed income tax returns and paid income taxes in 39 states. Maryland law allowed the couple a credit against their state income tax for those taxes paid to the other states but did not permit an unused state income tax credit against the Maryland county-level income tax. The Supreme Court struck down the denial of the excess state income tax credit against the county-level income tax, holding that the two taxes must be viewed as part of the same combined state tax system.

The Supreme Court explained:

In order to apply the [relevant test under the Commerce Clause], we must evaluate the Maryland income tax scheme as a whole…[f]or Commerce Clause purposes, it is immaterial that Maryland assigns different labels (i.e., "county tax" and "special nonresident tax") to these taxes. In applying the dormant Commerce Clause, they must be considered as one.

Wynne, 575 U.S. at 565 n. 8 (emphasis added).

Thus, the central holding in Wynne is that a credit must be given to offset a local tax in the taxpayer's state of residence, for a state tax paid to a different state. Otherwise, a state could avoid providing full credits to its residents for taxes paid to other states on income earned in the other states by simply authorizing its subdivisions to impose a portion of the tax and label that portion of the total tax as "local." The tax burden imposed by states and their political subdivisions is singular, and it is this collective burden that must be considered when evaluating constitutionality under the Commerce Clause.

Although the Supreme Court in Wynne emphasized that taxes upon income at the state level and the local level must be viewed together for Commerce Clause purposes, the courts below in Zilka did not adhere to that rule. Instead, they erroneously regarded the local tax as separate from the state tax when analyzing the burden upon interstate commerce. Therefore, they incorrectly reached the conclusion that there was no Commerce Clause violation.

A Collective Burden

The Philadelphia tax in this case should not be treated differently from the local tax at issue in Wynne. Nothing in Wynne supports distinguishing between taxes labelled as state taxes and those labelled as local taxes for purposes of the limitations contained in the Commerce Clause. To the contrary, for Commerce Clause purposes, under the reasoning and plain language of Wynne, such "labels" are neither dispositive nor relevant. The Supreme Court in Wynne provided an example that included both state level and local level taxes, and required that both taxes, whether imposed by the state or its subdivisions, be included when determining the burden upon interstate commerce.

In general, municipalities and local governments are nothing more than creatures of the state. Municipalities are not sovereign and have no powers apart from those that are granted by the state of which they are political subdivisions. Indeed, the Commonwealth of Pennsylvania dictates to Philadelphia what is permissible in the areas of legislation and taxation, just like the State of Maryland did with respect to the county-level tax in Wynne. That is, Philadelphia's power to tax arises solely from the General Assembly of the Commonwealth of Pennsylvania. As the Pennsylvania Supreme Court has observed on the state-municipality distinction in Pennsylvania law, neither "municipalities or school districts are sovereigns; they have no original or fundamental power of legislation or taxation. They have the right and power to enact only those legislative and tax ordinances or resolutions which are authorized by an Act of the legislature . . . ."

Appeal of School District of City of Allentown, 87 A.2d 480, 484 (Pa. 1952) (citations omitted).

Moreover, that Philadelphia's power to tax derives from the original taxing jurisdiction of Pennsylvania has been well-settled. Pennsylvania's highest court has noted that "the power of taxation, in all forms and of whatever nature lies solely in the General Assembly of the Commonwealth . . . ." Mastrangelo v. Buckley, 250 A.2d 447, 452-453 (Pa. 1969). Further, "[a]bsent a grant or a delegation of the power to tax from the General Assembly, no municipality, including Philadelphia, a city of the first class, has any power or authority to levy, assess or collect taxes." Id. Therefore, unless expressly authorized by the General Assembly, Philadelphia has no power to tax. In this case, the General Assembly has authorized Philadelphia to levy the Wage Tax. See The Sterling Act, Act of August 5, 1932, P.L. 45, 53 P.S. §15971.

Thus, the local tax at issue here is, fundamentally, a state tax. Unless the scheme is struck down and the Zilka taxpayer permitted to use her excess Delaware state credits against her Wage Tax liability, it would wrongfully permit Pennsylvania to make an end-run around the federal constitutional prohibition against taxing commercial activity between states more heavily than intrastate commerce.

Conclusion

A proper analysis of the Zilka facts using the clear guidance provided in Wynne requires that the Pennsylvania and Philadelphia taxes be viewed as a collective burden when analyzing the constitutionality of the scheme. After doing so, the unconstitutional nature of the scheme becomes clear.

While no date has been set yet by the Pennsylvania Supreme Court, oral argument in the case could occur as early as March 2023. The tax community will continue to follow this case containing crucial issues of national constitutional importance.

Read more about our firm's involvement with the case in our press release.

[1] The American College of Tax Counsel is a nonprofit professional association of tax lawyers in private practice, in law school teaching positions, and in government, who are recognized for their excellence in tax practice and for their substantial contributions and commitment to the profession