Maine Supreme Court Upholds Reduction of Taxpayer’s Credit for Taxes Paid to Norwegian County
When claiming resident tax credits for taxes paid to other jurisdictions (even ones outside the U.S.), the taxpayer must recalculate the amount of income subject to tax in the other jurisdiction as determined under the resident state’s rules.
By Jess Johannesen, SALT Manager
As an individual earning income in multiple states throughout the year, you’re paying income tax to several states each year. For states in which you are a nonresident, you’re only paying tax on the income that you earned in that state. In your resident state, however, your tax liability is based on all of your income from all sources.
In order to prevent (or at least mitigate) double taxation of income across the states, your resident state generally provides you with a state tax credit for income taxes paid to other states. Not all state income taxes are created equal, though, which can lead to instances where the credit allowed by your resident state may be less than the actual tax paid to the nonresident state. One cause of this is when the nonresident state income tax is not calculated on the same basis as the resident state income tax. In fact, this can also create an issue for states that give a credit for foreign taxes paid, as seen in a recent Maine Supreme Judicial Court opinion.
The taxpayers, a married couple, live in Maine and own two rental properties in Rogaland, Norway. During the years at issue, one of the properties was taken by “expropriation,” or the Norwegian equivalent of eminent domain. The taxpayers paid foreign income tax to Rogaland on both the rental income from the properties as well as the income from the expropriation. However, the foreign taxes were imposed based on gross income and did not allow any deductions for expenses related to the properties. When the taxpayers filed their Maine tax returns, they claimed a tax credit for the actual amount of foreign income tax paid. Since the tax credit exceeded their Maine income tax liability, the taxpayers ultimately paid no income tax to Maine.
On audit, the taxpayers’ Maine tax credit was recalculated and reduced causing an assessment of tax, interest and penalties. The Maine tax credit was reduced because the credit is allowed for tax paid on income that is taxed by bothMaine and the other taxing jurisdiction.Specifically, the statute states that “In determining whether income is derived from sources in another jurisdiction, the assessor may not employ the law of the other jurisdiction but shall assume that a statute equivalent to [Maine’s statute for calculating a taxpayer’s adjusted gross income from sources within the state] applies in that jurisdiction.”
Like most states, Maine taxes income after deductions for expenses (referred to as adjusted gross income or AGI). Since Norway taxed the gross income from the Norwegian properties, the taxpayers overstated their Maine tax credit since Maine would only tax the AGI from these foreign properties. The Court ruled in favor of the state, concluding that “[t]he [taxpayer’s] failure to properly account for the expenses attributable to the properties in the calculation of their foreign AGI resulted in a credit that exceeded their Maine tax liability on the income derived from Rogaland and effectively shielded them from tax liability on income that was never subject to tax in Rogaland—i.e., the interest, dividends and pensions they received while they were Maine residents and that was included in their Maine AGI.”
Many states’ income tax credits available to residents follow similar mechanics in that they don’t just accept how the nonresident state calculates the tax base. While the illustration in the this case addressed a political subdivision of a foreign country’s gross income-based tax vs. the state’s net income-based tax, similar instances may arise due to differences among state apportionment or sourcing methodologies. If you’re earning income in multiple states, do not assume that your resident state tax credit will be the actual dollar of nonresident state income taxes paid or that it will even be calculated according to the other state’s tax base.
Aprio has experience assisting clients with multistate personal and business income tax considerations and will make sure that your credits are maximized and calculated accurately. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the March 2019 SALT Newsletter.
ME Rev. Stat. Ann. §5217-A. It is worth noting that the credit is only applicable to income taxes imposed by “any political subdivision of a foreign country that is analogous to a state of the United States.” Thus, the tax credit here is for taxes imposed by and paid to Rogaland, a Norwegian county.
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.