Louisiana Supreme Court Declares Unconstitutional the Credit Limitation for Out-of-State Taxes Paid

A potential refund opportunity exists for individuals who do not get a full credit against their resident state taxes for income taxes paid to other states, according to this Louisiana Supreme Court case.

By Jeff Glickman, SALT Partner

Generally, states provide their residents an income tax credit for taxes paid to another state on income earned in that state.  A number of those states limit that credit to the amount of income tax that would be paid to the resident state (i.e., at resident state rates) based on the amount of income earned in the non-resident state.  In other words, if a resident of State A (with a 7 percent tax rate) earns $100,000 of income in State B (with a 10 percent tax rate), State A will provide a credit of $7,000 (even though the taxpayer paid $10,000 to State B).  If State B’s tax rates was 5 percent, then the State A credit would be $5,000.  Therefore, depending on the rate difference, a taxpayer may not get a full tax credit for taxes paid to non-resident states.

On Dec. 5, 2018, the Louisiana Supreme Court issued an opinion in which it declared that certain limitations on the tax credit (including the one mentioned above) are unconstitutional.[1]  In 2015, the Louisiana legislature enacted Act 109, HB 402, which amended Louisiana’s statute section 47.33(A) regarding credits for taxes paid to other states by adding, among others, the following provisions:

(4) The credit shall be allowed only if the other state provides a similar credit for Louisiana income taxes paid on income derived from property located in, or from services rendered in, or from business transacted in Louisiana.

(5) The credit shall be limited to the amount of Louisiana income tax that would have been imposed if the income earned in the other state had been earned in Louisiana.

The amendments were effective for any claim for a credit made on a return filed on or after July 1, 2015 (except for certain amended returns filed on or after that date).[2]

This case involved Louisiana residents (the “Taxpayers”) who were part owners of several pass-through entities (“PTE”) that did business in several states, including Texas.  The PTEs paid Texas Franchise Tax at the entity level, and the taxpayers took a credit on their 2015 Louisiana resident income tax return for their share of the Texas Franchise Tax paid by the PTEs.  Louisiana denied the credit based on the fact that Texas does not offer a reciprocal tax credit as required under (4) above, so the taxpayers paid the amount of the credit under protest and filed a claim for refund.[3]

The taxpayers claim that the credit limitations are unconstitutional under the Commerce Clause because they result in double taxation of income earned in interstate commerce but not intrastate commerce, violating the requirements that a state tax must be fairly apportioned and not discriminate against interstate commerce.[4]  The Court analyzed the credit limitations and determined that such limitation fails to apportion the out-of-state income and creates the potential for multiple taxation of the same income.

Specifically, with regard to the discrimination claim, the Court looked at each credit limitation separately.  With respect to the reciprocal limitation, the Court made clear such limitation results in the taxpayers paying income tax on their interstate (i.e., Texas) income twice (to Texas and Louisiana), whereas on their Louisiana income, the taxpayers only pay tax once (to Louisiana).

In addressing the credit limitation in (5), the Court determined that its effect is to discriminate against interstate commerce by taxing at least a portion of a taxpayer’s out-of-state income twice.  For example, assume a resident of State A (with a 7 percent tax rate) earns $200,000, of which $100,000 is earned in State B (with a 10 percent tax rate).  The taxpayer will pay a total of $10,000 of tax to State B ($100,000 times 10 percent).  In State A, the taxpayer’s tax liability is $14,000 ($200,000 times 7 percent), and instead of receiving a $10,000 tax credit for taxes paid to State B, the credit will be limited to $7,000 (i.e., the amount of the tax that would have been paid to State A on such income, which is $100,000 times 7 percent).  Therefore, the taxpayer pays a total of $17,000 in state taxes ($10,000 to State B and $7,000 to State A).  If the taxpayer had earned all if his income in State A, the tax would have only been $14,000.

For this analysis, the Court relied on the United States Supreme Court case of Comptroller of Treasury of Maryland v. Wynne, which addressed Maryland’s lack of a full credit for taxes paid to other states.[5]  The Wynne Court stated:

This case involves the constitutionality of an unusual feature of Maryland’s personal income tax scheme. Like many other states, Maryland taxes the income its residents earn both within and outside the state, as well as the income that nonresidents earn from sources within Maryland. But unlike most other states, Maryland does not offer its residents a full credit against the income taxes that they pay to other states. The effect of this scheme is that some of the income earned by Maryland residents outside the state is taxed twice. Maryland’s scheme creates an incentive for taxpayers to opt for intrastate rather than interstate economic activity.[6]

This case presents a significant opportunity for refund claims in states, like Georgia, that have a credit limitation similar to Louisiana.  Specifically, Georgia’s statutory tax credit for taxes paid to other states provides that, “In no case shall the credit permitted under this Code section exceed the tax which would be payable to this state upon a like amount of taxable income.”[7]

Contact Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the November/December 2018 SALT Newsletter.

[1] Ivan I. Smith and Gloria G. Smith v. Louisiana, No. 2018-CA-0728 (La. Sup. Ct., December 5, 2018).

[2] These amendments were originally set to expire on July 1, 2018, but in 2018 the state legislature enacted Act 6, HB 18, which amended the credit statute again, which included an extension of these provisions under July 1, 2023.

[3] Texas does not offer such a credit because it does not impose a personal income tax, and therefore a credit is not needed.

[4] These requirements are set forth in the United States Supreme Court case of Complete Auto Transit v. Brady, 430 U.S. 274 (1977), in which the Supreme Court stated that for a state tax to be valid under the Commerce Clause of the Constitution, it must (1) be applied to an activity with “substantial nexus” with the taxing state, (2) be fairly apportioned, (3) not discriminate against interstate commerce, and (4) be fairly related to the services provided by the state.  Requirements (1) and (4) were not involved in the Louisiana case.

[5] 135 S.Ct. 1787 (2015). The Wynne Court was not addressing the specific credit limitations in this case, but rather the fact that Maryland imposed state income taxes and county income taxes on residents, but only provided a credit for income earned out-of-state against the state, but not the county, income tax.

[6] Wynne, 135 S. Ct. at 1792.

[7] O.C.G.A. § 48-7-28.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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