Hull v. Comptroller of the Treasury

CHARLES E. ORTH, Jr., Judge (retired), Specially Assigned. This case is about the assessment of income taxes by the Comptroller of the State of Maryland against two nonresident former Maryland bay pilots. Pilots are covered by Article 74 of the Maryland Code (1957, 1983 Repl.Vol.). 1 Section 10 provides: Every foreign vessel and every American vessel engaged in foreign trade, including such vessels towing or being towed, when underway on navigable waters and within the boundaries of the State of Maryland, except when maneuvering during berthing or unberthing operations or shifting within the confine of a port with tug assistance and a docking master aboard the vessel, shall employ a pilot holding a valid warrant of appointment and license issued by the Board of Examiners of Maryland ⁸⁰ Pilots, or in case of refusal to take such a pilot shall themselves, their master, shipowner, charterers or ship’s husband pay the said pilotage as if a pilot had been employed.[ 2 ] The Board of Examiners of Maryland Pilots was created by the legislature. Sections 1-2. “No person shall be authorized or permitted to be a pilot unless he shall have first received a license from the Board,” § 5, and after serving an apprenticeship, §§ 3-4.

The Board “may make such rules and orders for the government and regulation of pilots licensed by them as they may think proper, not contrary to the provisions of [Art. 74]____” Section 9. The Board is “authorized and directed to establish, at just and reasonable rates, pilotage fees and charges____” Section 14. See § 13 for liability for pilot’s compensation. The pilots licensed by the Board formed the Association of Maryland Pilots.

Each pilot becomes a member of the Association upon obtaining his license. As a member he has a vote in the management and operations of the Association and makes a capital contribution. A “full member pilot” is a pilot who holds a warrant of appointment and license for any draught of water issued by the Board of Examiners of Maryland Pilots and is a member in good standing of the Association of Maryland Pilots. Section 12(c).

A “lawfully licensed pilot” is a pilot who holds any warrant of appointment and license issued by the Board of Examiners of Maryland Pilots and is a member in good standing of the Association of Maryland Pilots. Id. A pilot shall be deemed to be inactive within the meaning of this section from and after the last day of the month (i) in which such pilot attains the age of seventy (70) years, or ⁸¹ (ii) in which such pilot elects to be placed upon the inactive list after having been a full member pilot of the Association of Maryland Pilots for twenty-five (25) years or more. Id.

A pilot shall be considered permanently incapable of performing his duties within the meaning of this section from and after the date upon which (1) said pilot has been certified as such by two doctors selected by the Board of Examiners of Maryland Pilots and until such incapacity ceases to exist, or, (2) said pilot’s federal or State license has been revoked for reasons of physical disability and until such license or licenses have been reissued. Id. The pilotage fees are payable to the Association as collection agent for its members. Each month a certain portion of the fees received by the Association are first turned over to the Board in an amount equal to two hundred dollars ($200.00) or 33Vs% of the said monthly distributive portion to which a full member pilot engaged in full active service is entitled to receive for such calendar month, whichever is the greater, times the number of living pilots of the Association of Maryland Pilots who at the beginning of such month are either inactive or permanently incapable of performing their duties as hereinafter defined and who prior to becoming inactive or disabled were full member pilots of the Association of Maryland Pilots; the Board of Examiners of Maryland Pilots shall within ten (10) days after receipt of the sum or sums fixed in this subsection disburse the same equally to such of the living pilots of the Association of Maryland Pilots, who, at the beginning of the calendar month for which said payment is made, were either inactive or permanently incapable of performing their duties as pilots as hereinafter defined and who prior to becoming inactive or disabled were full member pilots of the Association of Maryland Pilots. ⁸² Section 12(a).

The balance of said money available for distribution, after the payment of all expenses, shall be distributed monthly in accordance with the bylaws of the Association of Maryland Pilots among the regular working lawfully licensed pilots of the Association; provided, however that the board of supervisors of the Association of Maryland Pilots is empowered, authorized and directed to deduct from such money collected and before such monthly distribution among the regular working lawfully licensed pilots, a certain percentage of said money, said percentage to be fixed by the Board of Examiners of Maryland Pilots to be set aside in a separate or reserve fund for replacement and repairs of major equipment. The Board of Examiners of Maryland Pilots shall hold said replacement and repair funds in trust for the benefit of the Association of Maryland Pilots. In making investments or reinvestments of the funds the Board of Examiners of Maryland Pilots shall not be limited or restricted to property of the character designated as strictly suitable for the investment of trust funds by any law of the State of Maryland, but is hereby expressly authorized and empowered to invest or hold such property as may be, in its opinion, be desirable, considering the nature and purposes of the trust; or may at its election, place the management and control of the fund, or a portion thereof, in a bank or trust company subject to State or federal regulation. The assets held in trust under the authority of this section shall not be subject to attachment or execution.

Section 12(b). The amount paid to each pilot who, before becoming inactive or disabled were full members of the Association, is identical, and does not depend upon length of service in the Association. He is guaranteed a minimum of $200 a month regardless of the Association’s profits or losses. Upon becoming inactive or upon being declared permanently disabled, a pilot loses his membership in the Associa ⁸³ tion and is paid his capital investment.

He no longer receives the monthly distribution paid by the Association to regularly working full members pursuant to § 12(b). He has no voice in the management of the Association, loses his license to pilot and has no relationship with the Association. He is then neither a “full member pilot,” nor a “lawfully licensed pilot,” as statutorily defined. In short, he is no longer a pilot or a member of the Association.

William Hull and Thaddeus Smurlo were full member pilots, each holding a warrant of appointment and license issued by the Board for any draught of water. Each was a member in good standing of the Association. Hull elected to be placed on the inactive list in 1970 after 40 years of service. In 1976, after 20 years of service, Smurlo was considered to be permanently incapable of performing his duties.

Each of them, Hull upon becoming inactive, and Smurlo upon being declared disabled, lost his license to pilot and his membership in the Association and was no longer the recipient of the monthly distribution made to the “regular working lawfully licensed pilots of the Association” pursuant to § 12(b). The capital contribution of each of them was returned. Neither of them then had a vote or any voice in the management of the Association’s affairs and performed no services for or on behalf of the Association. All their connections with the Association were severed.

They had nothing at all to do with it. Effective upon Hull’s becoming inactive and Smurlo’s disablement, each of them began to receive the monthly distribution from the Board pursuant to § 12(a). The Association is treated as a partnership for tax purposes. The monthly distribution paid to the active members of the Association pursuant to § 12(b) is reported by the Association on tax form K-l.

The monthly distribution made by the Board to inactive and disabled former members of the Association is reported by the Board on tax form 1099. Inasmuch as the inactive and disabled former pilots are not considered by the Association or the Board to be members of or partners in the Association, that portion of the pilot- ⁸⁴ age fees collected by the Association which is turned over to the Board for distribution is not treated or reported as partnership income but as an expense of the Association. Early in 1984, the Comptroller of the Treasury of Maryland issued a Notice of Assessment for Maryland income taxes to Hull for tax years 1980-1982 and to Smurlo for tax years 1980-1983. During the years covered by the assessments Hull and Smurlo resided in Florida and were not domiciled in Maryland.

They owned no property in Maryland and performed no services in Maryland. The assessment was based on the monies received from the Board pursuant to § 12(a). Hull and Smurlo appealed to the Maryland Tax Court. It held in a combined order that the nonresident taxpayers were not subject to tax in Maryland and abated the assessments.

The Comptroller appealed to the Circuit Court for Baltimore City. It reversed the order of the Tax Court and reinstated the assessments. Hull and Smurlo appealed to the Court of Special Appeals. We ordered the issuance of a writ of certiorari on our own motion before decision by that court.

Maryland Code (1957, 1980 Repl.Vol.) Art. 81, § 287, provides, in relevant part: A nonresident individual shall be taxable in this State on that portion of his federal adjusted gross income as is derived from ... income from business, trade, profession or occupation carried on in this State____[ 3 ] ⁸⁵ The Maryland Tax Court thought that § 287 of Art. 81 “only seeks to tax income derived from activities conducted in Maryland in which a nonresident plays some direct role.” The Tax Court declared that “[t]he parties themselves appear to agree to this interpretation,” and following that construction, the Tax Court found that the income [Hull and Smurlo] received during the subject years would not be taxable under Section 287 because [they] were no longer members of the Association of Maryland Pilots, did not provide it with any services, and did not assist in its management. [They] also did not have any capital invested in the partnership. The Tax Court noted, “Nonetheless, the Comptroller contends that [Hull’s and Smurlo’s] income is taxable under Section 315 [of Art. 81]____” That section provides, inter alia: Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity, and no income tax shall be assessable hereunder upon the income of any partnership. All such income shall be assessable to the individual partners; it shall be reported by such partners as individuals upon their respective individual income returns, and it shall be taxed to them as individuals along with their other income____ The Comptroller argued that “[s]ince the active members of the Association of Maryland Pilots obviously do carry on business in Maryland, ... [Hull and Smurlo] are liable for tax under Sections 315 and 287.” The Tax Court disagreed. It thought that Maryland Code (1975, 1985 Repl.Vol.) § 9-101(f) of the Corporations and Associations Article was dispositive.

It defines a partnership to mean “an association of two or more persons to carry on as co-owners a business for profit.” The Tax Court concluded: Since [Hull and Smurlo] have no ownership interest in the Maryland Pilots Association, the income they receive is not partnership income for purposes of Sections 287 and 315. ⁸⁶ The Circuit Court for Baltimore City reversed the Tax Court. The court recognized that Hull and Smurlo are retired Maryland Bay Pilots who do not reside in Maryland and who are not domiciled in Maryland. They receive income from the Maryland Bay Pilots Association ..., a partnership for federal tax purposes, pursuant to Md.Code, Art. 74, § [12]. [They] do not have capital accounts with the Association, do not actively participate in the Association and are not considered members of the Association. But the court pointed out Art. 81, § 287 provided that a nonresident shall be taxable on “income from business, trade, profession or occupation carried on in this State____” The court said, “The test to determine whether the income arises within the State is whether the taxing power exerted by the State bears fiscal relation to protection, opportunities and benefits given by the State, Wisconsin v. J.C. Penney Co., 311 U.S. 435 [, 61 S.Ct. 246 , 85 L.Ed. 267 ] (1940).” The court noted: “It is clear that [the income of Hull and Smurlo] that is sought to be taxed is completely dependent on the protection, opportunities and