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The Supreme Court justices may want to brush up on their tax law this summer. It seems that there are more tax cases on the docket lately.

A few days after the Supreme Court unanimously ruled on a federal estate tax matter (holding that a corporation’s obligation to repurchase stock does not necessarily constitute a liability that reduces its value for estate tax purposes), the justices took up a new case, asking the Solicitor General of the United States to weigh in on a state and local issue.

background

The applicant, Diane Zilka, lives in Philadelphia, Pennsylvania, and works just downstream in Wilmington, Delaware.

Pennsylvania allows residents who work out of state to claim a credit for income tax payments in other states, such as Delaware. In this case, Pennsylvania imposed a flat tax of 3.07% on Zilka—and Delaware imposed a 5% tax on Zilka. Because Pennsylvania has a lower state tax rate, the Keystone State allowed Zilka to apply her Delaware tax as a credit against her Pennsylvania tax, resulting in a difference of 1.93% (more tax paid to Delaware).

Likewise, Philadelphia gives its residents a credit to offset income tax payments to other cities, such as Wilmington. In this case, Philadelphia gave Zilka a credit equal to the amount of taxes paid in Wilmington (1.25%) to offset her Philadelphia tax (3.92%). Since Zilka still had a deficit, she also tried to claim a credit equal to 1.93% of her Philadelphia tax, which could not be claimed at the state level.

The Philadelphia Department of Revenue allowed her the Wilmington tax credit (1.25%) against her Philadelphia tax liability, but did not allow her to apply the unused Delaware credit (1.93%) to her Philadelphia taxes.

Zilka appealed the decision to the Philadelphia Tax Review Board. The Tax Review Board denied the appeal and the matter went to court (first to the Court of Common Pleas and then to the Commonwealth Court of Pennsylvania), both of which ruled in Philadelphia’s favor. The matter then went to the Pennsylvania Supreme Court, which held that Philadelphia was not required to grant Zilka another credit to satisfy her remaining Delaware income tax debt.

Ask

The question is whether the Commerce Clause requires states to consider a taxpayer’s burden in light of the entire state tax system when imputing an out-of-state taxpayer’s tax liability, or whether states are permitted to impute out-of-state state and local tax liabilities as a separate tax burden, as the Pennsylvania Supreme Court has previously held.

Arguments

Zilka refers to the decision of the US Supreme Court in Comptroller v. Wynne (2015), which found that Maryland’s tax system was unconstitutional because it did not offer its residents a credit for taxes paid in other states. In Wynne, a married couple (the Wynnes) reported approximately $2.7 million in net taxable income to the State of Maryland. More than half of that amount represented a share of the profits of an S corporation with offices in multiple states. The Wynnes claimed a credit for taxes paid in 39 other states on their Maryland tax returns. The State of Maryland denied the credits and issued a notice of tax deficiency. The Wynnes appealed and the tax assessment was affirmed, meaning they were left with the burden of paying the taxes. The matter eventually went to the Supreme Court, which found that “Maryland’s income tax system violates the dormant commerce clause.” The dormant commerce clause emerged in principle in the 19th century and now means that states may not discriminate against or unduly burden interstate commerce, even if there are no specific federal laws regarding commerce.

Zilka argued that the decision in Wynne meant that states must offer full credits, including local taxes, on interstate income taxes to avoid unconstitutional multiple taxation. But Philadelphia only offered a credit on Wilmington’s taxes. This, Zilka argued, resulted in her paying a higher tax simply because she worked out of state – a dormant violation of the Commerce Clause.

Stewart Weintraub, a shareholder at Chamberlain Hrdlicka who is representing Zilka in the case, says the argument “simply boils down to (Zilka’s) equal income being taxed by four different taxing authorities.” And, Weintraub said, if you do the math, “more than 100 percent of her income is being taxed.”

The decision could have consequences that extend beyond the City of Brotherly Love. Weintraub points out that any city with a local income tax that borders another state could be affected – as could other commuters. And he points out that there could be sales tax implications as well.

In contrast, Philadelphia claims that it imposes the same tax rate on all residents, so its tax system cannot be discriminatory under the dormant commerce clause. The city also argues that the facts of the relevant tax in Wynne are distinct from the features of the payroll tax in Philadelphia. Finally, Philadelphia agrees that Zilka has a higher tax bill not because of discrimination against interstate commerce, but because of “the interaction of two parallel and nondiscriminatory income tax systems at different levels.”

The city of Philadelphia declined to comment for this article, citing ongoing litigation.

Supreme Court

Zilka filed a petition for certiorari (Latin for a written order “to be more fully informed”) with the Supreme Court on February 20, 2024. Parties do this when they seek review of a case – usually in response to a decision by an appellate court.

In his petition, Zilka argues that the Supreme Court must hear the case because “Pennsylvania’s decision to treat Philadelphia as a separate sovereign from Pennsylvania would create a new loophole in the Constitution that conflicts with the Wynne decision and the laws of nearly every other state, and because what matters is how taxes work in practice, not the labels used by government officials.” They also argue that the prohibition on discriminatory burdens on interstate commerce includes local taxes.

The National Taxpayers Union Foundation and the American College of Tax Counsel filed amicus curiae briefs in support of Zilka.

In its response, Philadelphia argues that the Pennsylvania Supreme Court correctly decided the issue and that the question raised by Zilka is “neither recurring nor important.” And the city contends that the Pennsylvania Supreme Court did not believe Wynne required a different result. It writes, “In our view, (Wynne’s) logic and characterization of the county tax as a state tax, based on the circumstances underlying its creation and the manner in which it is collected by the state controller, demonstrate that state and local taxes need not be aggregated for purposes of a dormant Commerce Clause analysis.”

The Supreme Court has not yet agreed to hear the case. On June 10, 2024, the Court asked the Attorney General to file a brief setting out the United States’ views.

If the Supreme Court decides to hear the case, it is called a grant of certiorari (in practice, at least four justices must vote to hear the case for certiorari to be granted). If the Supreme Court denies the petition, it is called a denial of certiorari. A denial does not necessarily mean that the Court agrees with the appellate court’s findings—it simply means that the appellate decision stands.

Provided that the certificate is granted, negotiations will not begin until autumn at the earliest.

The case is Zilka v. Tax Review Board of the City of Philadelphia.

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