Comptroller of the Treasury v. Hickey

³⁹⁰ CATHELL, Judge. At issue in this case is the application of section 10-703(c)(l) of the Tax-General Article. With certain exceptions, section 10-703(a) provides taxpayers with a credit against Maryland income tax “for tax on income paid to another state.” The amount of this credit is determined under section 10 — 703(c)(1). This section provides: [T]he credit allowed a resident under subsection (a) of this section is the lesser of: (i) the amount of allowable tax on income that the resident paid to another state; or (ii) an amount that does not reduce the State income tax to an amount less than would be payable if the income subjected to tax in the other state were disregarded.

Md.Code (1988, 1996 Supp.), § 10-703(c)(l) of the Tax-General Article (TG). Mr. and Mrs. Robert Hickey, appellees, are residents of Maryland. During the relevant tax years, 1988 to 1990, Mr. Hickey was a partner in the Washington, D.C. office of a law firm that maintained offices in both New York and Washington. Although Mr. Hickey worked exclusively in Washington, some of his income was deemed taxable by the State of New York. 1 Appellees filed nonresident New York State income tax returns for the years 1988 to 1990 and paid New York income tax.

Pursuant to section 10-703(c)(l)(i) of the Tax-General Article, appellees claimed a credit on their Maryland Tax returns for the years 1988 to 1990 that was equal to the amount of income tax paid to New York. The Comptroller of the Treasury (the Comptroller), appellant, reduced appellees’ credits for the relevant tax years. The Comptroller asserted that a credit could not be claimed for the entire amount of income tax paid to New York and reduced appellees’ credits by applying section 10-703(c)(l)(ii) of the Tax-General Article, as interpreted by the Comptroller. This reduction in the tax credits for the tax years 1988 ³⁹¹ through 1990 caused a reduction in appellees’ tax refunds for those years.

Appellees, asserting that the Comptroller improperly applied section 10-703(c)(l)(ii) of the Tax-General Article and that the Comptroller improperly denied their refund claims, filed a Petition of Appeal in the Maryland Tax Court. In ruling in favor of the Comptroller, the Tax Court interpreted section 10 — 703(c)(1) so that “the amount of tax due the State of Maryland cannot be reduced below a number that would be payable to the State of Maryland if the income from the other state had not been received by the taxpayer at all.” Appellees thereafter appealed to the Circuit Court for Montgomery County, which reversed the Tax Court’s decision. In reversing the Tax Court, the circuit court reasoned: The objective of income tax credit provisions is to avoid double taxation by providing for a credit against the Maryland income tax liability to the extent that income taxed by Maryland is also taxed in another jurisdiction. Section 10-703 of the Tax-General Article achieves this objective by focusing on the income tax subjected to tax by another state. [Appellees] argue that Section 10 — 703(c)[ (1) J (i) applies to the case sub judice and that the Comptroller’s interpretation of the statute, therefore, violates the plain meaning of the language of the statute; whereas, the Comptroller claims that Section 10-703(c)[ (1) ] (ii) applies because New York State’s method of taxing non-resident income does in fact lower the Maryland income tax which would be payable if the income subject to New York State income tax was disregarded.

This Court finds that the Comptroller’s and the Tax Court’s reading of the statute is in stark contrast with public policy and Maryland law. The purpose of section 10-703 is to avoid double taxation. If the Tax Court’s decision is permitted to stand, [appel-lees’] and all similarly situated taxpayers will be subject, in varying degrees, to double taxation. The Comptroller presents one question on appeal: ³⁹² Did the Circuit Court err when it allowed New York’s distinctive method of tax calculation to effectively repeal the Maryland statutory limitation on credit for income taxes paid to another state?

We answer this question in the affirmative and shall reverse the judgment of the circuit court. The controversy in the case sub judice involves the application of section 10 — 703(c)(1) (particularly subsection (c)(l)(ii)) of the Tax-General Article, which provides for the amount of credit that a taxpayer may take for income tax paid to another state. The credit is equal to the lesser of: (i) the amount of allowable tax on income that the resident paid to another state; or (ii) an amount that does not reduce the State income tax to an amount less than would be payable if the income subjected to tax in the other state were disregarded. TG § 10-703(c)(l)(emphasis added).

Appellees argue that the application of this section to their factual situation permits them to take a credit pursuant to section 10-703(c)(l)(i). They aver this is so because of the method by which New York taxes nonresidents. New York determines a nonresident taxpayer’s tax rate, and therefore his or her tax liability, referred to in New York as a taxpayer’s “tax base,” based upon all of a nonresident taxpayer’s income, including that actually taxable in New York and all other income as well. The tax liability, tax base, is then reduced by multiplying the tax liability by a percentage equal to the income earned in New York divided by the taxpayer’s total income.

Appellees argue that under New York’s tax laws, all of their income was “subject to tax” in New York. 2 They further argue that the application of ³⁹³ section 10-703(c)(l)(ii) results in an amount which is greater than the amount obtained by application of section 10-703(c)(l)(i). Appellees thus assert that they correctly claimed a credit pursuant to section 10 — 703(c)(l)(i) for the entire amount of income taxes paid to New York. The Comptroller disagrees with appellees’ application of section 10-703(c)(l)(ii). The Comptroller asserts that, although New York determines a nonresident taxpayer’s income tax rate and income tax liability (tax base) based upon all of his or her income, the income tax liability (tax base) is then reduced by multiplying the tax liability (tax base) by a percentage, which is obtained by dividing the income allocable to New York by the taxpayer’s total income.

Therefore, the Comptroller asserts, all of a taxpayer’s income is not “subject to tax” in New York and this percentage should be multiplied by the amount appellees claimed was “subject to tax” in New York. The Comptroller’s application of section 10 — 703(c)(l)(ii) results in a lesser credit than that claimed by appellees. APPLICATION AND PURPOSE OF SECTION 10-703(c)(l) Section 10~703(c)(l) of the Tax-General Article provides the amount of credit a taxpayer may take if that taxpayer paid income tax to another state. The credit is limited to the lesser of the amount of income tax paid to the other state or “an amount that does not reduce the State income tax to an amount less than would be payable if the income subjected to tax in the other state were disregarded.” TG § 10-703(c)(l)(i)-(ii).

The amount of income tax paid to another state is generally obtained by multiplying the income allocable to the other state by the appropriate income tax rate. There are states, however, such as New York, that impose an income tax rate on nonresidents based on all income and then reduce that tax liability (tax base) by multiplying the tax liability by a percentage. ³⁹⁴ The following example illustrates the application of section 10-703(c)(l)(i) in states that calculate a taxpayer’s income tax according to the income allocable to that state, i.e.., non New York-type tax structures: Example 1 — TP earned $100,000; of this, $60,000 was earned in Maryland, and $40,000 was earned in State X. State X taxes the income earned in that state at 10%. TP would pay $4,000 ($40,000 * .10) of tax to State X, and this would be the tax credit TP would be permitted to take under section 10-703(c)(l)(i). Calculating the tax credit under section 10 — 703(c)(l)(ii) is slightly more complicated.

The credit under this section is equal to “an amount that does not reduce the State income tax to an amount less than would be payable if the income subjected to tax in the other state were disregarded.” TG § 10-703(c)(l)(ii). The language of this section indicates that the credit is equal to the Maryland State income tax payable less the Maryland State income tax that would be payable if the income “subject to tax” in the other state were disregarded. The example below illustrates the application of section 10-703(c)(l)(ii): Example 2 — TP earned $100,000; of this, $60,000 was earned in Maryland, and $40,000 was earned in State X. State X taxes the income earned in that state at 10%. Maryland also taxes its income at 10%.

Under section 10-703(c)(l)(ii), TP would be permitted to take a credit of $4,000 (($100,000 * .10) — (($100,000—$40,000) * .10)). Pursuant to section 10-703(c)(l)(i), the credit would be the same, $4,000 ($40,000 * .10). A Maryland taxpayer would therefore pay a Maryland income tax of $6,000 (($100,000 * .10) — $4,000). As can be seen from the above examples, the credit is the same under both subsections (c)(l)(i) and (c)(l)(ii) of section 10-703 when the tax rate in the two states is the same.

Additionally, the examples illustrate one of the purposes of section 10-703(c)(l): to avoid double taxation of income. See Roach v. Comptroller of the Treasury, 327 Md. 438, 449 , 610 ³⁹⁵ A.2d 754 (1992) (“The obvious purpose of the credit granted by § 10-703 of the Tax-General Article is to avoid double taxation on the same income.”). Another purpose of section 10-703(c)(l) is to ensure that Maryland collects the same amount of income tax, even though another state may impose a higher tax rate on the income allocable to that state. The example below illustrates this purpose: Example 3 — TP earned $100,000; of this, $60,000 was earned in Maryland, and $40,000 was earned in State X. State X taxes income earned in that state at 15%.

Maryland taxes income at 10%. Under section 10 — 703(c)(l)(i), TP would pay $6,000 ($40,000 * .15) in taxes to State X. Under section 10-703(c)(l)(ii), TP’s credit would be equal to $4,000 (($100,000 * .10) — (($100,000—$40,000) * .10)). Therefore, TP’s credit would be limited to $4,000. TP would have to pay $6,000 (($100,000 * .10) — $4,000) in taxes to Maryland.

As this example, when compared with Example 2, illustrates, Maryland receives the same amount of income tax ($6,000) even though the other state taxes income allocable to that state at a rate higher than the Maryland rate. THE PARTIES’ CONTENTIONS The disagreement in this case revolves around the application of section 10 — 703(c)(l)(ii) to states, such as New York, that determine a taxpayer’s tax rate and tax liability (tax base) based upon all of his or her income, regardless of where that income was earned. That tax liability (tax base) is then reduced by multiplying it by a percentage. The Court of Appeals of New York described its tax laws relative to nonresident taxpayers in Brady v. State, 80 N.Y.2d 596 , 592 N.Y.S.2d 955 , 607 N.E.2d 1060, 1061-62 (1992): Under Tax Law § 601(e)(1), the tax of a nonresident is first calculated “as if [the taxpayer] were a resident.” Thus, the nonresident’s tax base ... is determined by applying the appropriate graduated rate in Tax Law § 601(a) through (c) to the taxpayer’s total income from all sources (less any ³⁹⁶ statutory deductions, exemptions or credits).

The taxpayer’s total income is derived from “New York adjusted gross income”, which is determined by reference to the taxpayer’s “federal adjusted gross income”. Residents pay their entire tax base. For nonresidents, however, the amount is reduced by the percentage of income earned in New York compared to total income. Therefore, while residents and nonresidents with the same total income are taxed at the same rate, the nonresident pays tax only on the percentage of income attributable to New York. [Brackets in original; citations omitted; footnote omitted.] Appellees argue that, in such states, all of a taxpayer’s income is “subject to tax.” Therefore, the application of section 10-703(c)(l)(ii) yields a larger credit than does section 10 — 703(c)(l)(i).

The example below illustrates appellees’ contention: Example J+ — TP earned $100,000; of this, $60,000 was earned due to activities in Maryland, and $40,000 was earned due to activities in New York. Maryland imposes a tax rate of 10%, while New York imposes a tax rate of 15%. The tax payable in New York would be $6,000 (($100,000 * .15) * ($40,000 / $100,000)). This would also be the amount of TP’s credit under section 10 — 703(c)(l)(i).

The amount of the credit under section 10 — 703(c)(l)(ii) would be $10,000 (($100,000 * .10) — (($100,000—$100,000) * .10)). The amount of the credit under section 10-703(c)(l)(i) is less, and therefore, TP would be able to take a credit for all the income tax paid to New York and pay $4,000 (($100,000 * .10) — $6,000) of tax to Maryland. The Comptroller disagrees with appellees’ application of section 10 — 703(c)(l)(ii). The Comptroller argues that in calculating the credit under section