Frey v. Comptroller of The Treasury.

• Decision Date: 29 September 2011
• Docket Number: No. 62,Sept. Term,2009.,62
• Citation: 29 A.3d 475,422 Md. 111
• Parties: Timothy A. FREY, et al.v.COMPTROLLER OF the TREASURY.
• Court: Maryland Court of Appeals

422 Md. 111

29 A.3d 475

Timothy A. FREY, et al.

v.COMPTROLLER OF the TREASURY.

No. 62

Sept. Term

2009.

Court of Appeals of Maryland.

Sept. 29, 2011.

Harry D. Shapiro (Seth J. Groman of Saul Ewing LLP, Baltimore, MD), on brief, for petitioners/cross-respondents.John K. Barry, Asst. Atty. Gen. (Douglas F. Gansler, Atty. Gen. of Maryland, Baltimore, MD), on brief, for respondent/cross-petitioner.Argued before BELL, C.J., HARRELL, BATTAGLIA, GREENE, MURPHY, ADKINS and BARBERA, JJ.BARBERA, J.

In this case we consider the State's authority to impose a certain tax known as the “Special Nonresident Tax” (“SNRT”) upon nonresidents who neither live nor work in Maryland but have a source of income in the State. Petitioners David S. and Judith W. Antzis, Timothy A. and Mary S. Frey, and Rudolph Garcia and Randi E. Pastor–Garcia reside in Pennsylvania but pay Maryland State income taxes on the income earned by each husband as a partner in Saul Ewing, LLP (“the firm”), a multi-state law firm with offices in Maryland, Pennsylvania, Delaware, Washington, D.C., New York, and New Jersey. In 2005, the Comptroller of the Treasury issued a notice of assessment against Petitioners' 2004 joint Maryland nonresident income tax returns for failure to pay the SNRT.¹ The assessment included the amount owed for the SNRT, interest, and a penalty. Petitioners challenge, on federal and state constitutional grounds, the State's authority to impose the SNRT.

I.

Maryland residents ² and nonresidents alike are taxed under Maryland Code (1988, 2004 Repl.Vol.), § 10–105 of the Tax General Article (“T.G.”), ³ which establishes the State income tax rates.⁴ In addition, Maryland residents are subject to a county tax, which is mandated by T.G. § 10–103 and § 10–106.⁵ The rate of a resident's county tax is determined by where the resident is domiciled on the last day of the taxable year. § 10–103(a)(1)(i). The only county income taxes permitted in the State are those prescribed in these sections of the Tax General Article, and the counties have no authority to impose income taxes other than those established by State statute. See T.G. § 10–103(b). Residents file a single tax return that reflects both county and State income taxes.

The Comptroller collects all taxes imposed under the Tax General Article, accounts for the revenue from those taxes, and distributes that revenue as directed in the Tax General Article. See T.G. § 2–109(a)(1)–(3). As to the State and county income taxes, the Comptroller collects them and, after distributing a portion of each income tax to various State funds designated by statute, see T.G. §§ 2–604 through 2–607, the Comptroller distributes the remaining State income tax revenue to the General Fund, T.G. § 2–609, and “distribute[s] to each county the remaining income tax revenue from individuals attributable to the county income tax for that county,” T.G. § 2–608(a). In other words, the Comptroller ultimately directs State income tax revenue to the General Fund for State use and directs the local income tax revenue to the counties for their use.⁶

Of course, because nonresidents have no State county of residence, they are not required under T.G. § 10–106 to pay a local tax. Nonresidents are, however, subject to the SNRT. In 2004, the General Assembly enacted the SNRT, which applied retroactively to “all taxable years beginning after December 31, 2003.” 2004 Md. Laws Ch. 430 § 30. The SNRT is codified at T.G. § 10–106. 1(a) and requires that “[a]n individual subject to the State income tax under § 10–105(a) of this subtitle, but not subject to the county income tax under § 10–106 of this subtitle, shall be subject to the tax imposed under this section.” ⁷ T.G. § 10–106.1(a). The section further provides that “[t]he rate of the tax imposed ... shall be equal to the lowest county income tax rate set by any Maryland county in accordance with § 10–106 of this subtitle.” ⁸ T.G. § 10–106.1(b). Although not obvious without reference to the cited statutory provisions, the SNRT imposes on nonresidents, in addition to the Maryland State income tax, an income tax equal to the lowest county tax rate available during the applicable tax year.

During the time period relevant to this case, § 10–106.1 required a nonresident who owed income taxes in Maryland to pay the State income tax of 4.75%, see T.G. § 10–105(a)(4)(v), and a tax equal to the lowest county tax rate imposed by any county in the State, which, at the time, was 1.25%. The SNRT, however, is not distributed to any particular county after it is collected by the Comptroller. Instead, T.G. § 2–609 provides that, “[a]fter making the distributions required under §§ 2–604 through 2–608.1 of this subtitle, the Comptroller shall distribute the remaining income tax revenue from individuals to the General Fund of the State.” In other words, the Comptroller distributes to the taxpayers' county of residence the remaining county tax revenue, and then deposits the remaining SNRT revenues into the State's General Fund.

This Case

During 2004, Petitioners, though residents of Pennsylvania who worked outside of and owned no property in Maryland, paid State income taxes and local real estate and personal property taxes to the respective State subdivisions. At that time, Messrs. Antzis and Garcia conducted their legal practice in Pennsylvania, in Chesterbrook and Philadelphia, respectively, and Mr. Frey conducted his legal practice in Wilmington, Delaware. The firm is a partnership formed in Delaware, but, because it earns income in each of the states in which its offices are located, the firm apportions its income among these states when reporting its income. As a result, during the relevant time period, the firm reported taxable income and paid the applicable State income and other taxes in Maryland for each of the firm's partners, including Petitioners. See T.G. § 10–102.1 (imposing State income tax on partnerships with nonresident partners and requiring such partnerships to pay that tax on behalf of such partners). These taxes are not in dispute.

The Litigation

As mentioned, Petitioners did not pay the additional SNRT imposed on their income attributed to the firm's operations in Maryland, and consequently, in 2005, the Comptroller issued notices of assessment to Petitioners for the unpaid SNRTs.⁹ In response, and pursuant to T.G. § 13–508, ¹⁰ Petitioners asked the Comptroller to revise the assessment, at an informal hearing held on September 19, 2005. On September 26, 2005, the Comptroller issued to each Petitioner a Notice of Final Determination affirming the assessment.

At the hearing, Petitioners presented the same constitutional challenges they raise in this appeal. The hearing officer summarized those arguments as follows:

[Petitioners argue that] the special nonresident tax violates the Interstate Commerce Clause and Due Process Clause of the United States Constitution, as well as the Maryland Constitution. The basis for this claim is that the [SNRT] places a tax burden on nonresidents that is not imposed on residents.... [SNRT] is distinguishable from the local tax imposed on Maryland residents because the tax revenue from the [SNRT] goes to the State of Maryland, while the tax revenue from the resident local tax goes to the Maryland counties.

The hearing officer determined as an initial matter that Petitioners' constitutional challenges to the SNRT exceeded the scope of the hearing. The officer then determined that, based on the information presented at the hearing, the assessment was consistent with T.G. § 10–106.1. The officer therefore affirmed the assessment.

The Tax Court

On October 24, 2005, Petitioners individually appealed to the Maryland Tax Court.¹¹ On February 15, 2006, upon the Comptroller's motion, that court consolidated Petitioners' cases, and on May 10, 2006, heard the parties' arguments. Neither party offered testimony, however, because they had agreed to a stipulation of the background and facts pertinent to the appeal. On June 22, 2006, the Tax Court affirmed the assessments on Petitioners but abated the penalties.

The court acknowledged at the outset Petitioners' argument that, because the SNRT imposes a nonresident tax that is applicable solely to nonresident income, not resident income, the provision is facially discriminatory and therefore violates the United States Constitution and the Maryland Constitution and Declaration of Rights. To support that contention, Petitioners cited Fulton Corp. v. Faulkner, 516 U.S. 325, 116 S.Ct. 848, 133 L.Ed.2d 796 (1996), in which the Supreme Court emphasized that state laws that are facially discriminatory against interstate commerce are “virtually per se invalid.” 516 U.S. at 331, 116 S.Ct. 848 (internal quotation marks omitted) (quoting Or. Waste Sys., Inc. v. Dep't of Env't Quality, 511 U.S. 93, 99, 114 S.Ct. 1345, 128 L.Ed.2d 13 (1994)). Although the court neither denied this characterization of Fulton nor that “§ 10–106.1 ... appear[s] to discriminate against the out-of-state taxpayer,” the court reasoned that an “appearance of discrimination ... does not end the inquiry.”

Under the Tax Court's interpretation of Fulton, when a tax is facially discriminatory and therefore presumed invalid, the government may overcome this presumption by showing that the statute is a “ ‘compensatory tax’ designed simply to make interstate commerce bear a burden already borne by intrastate commerce.” 516 U.S. at 331, 116 S.Ct. 848 (internal quotation marks omitted) (quoting Associated Indus. of Mo. v. Lohman, 511 U.S. 641, 647, 114 S.Ct. 1815, 128 L.Ed.2d 639 (1994)). To do so, however, the court pointed out that the government must satisfy a three-prong test applied in Fulton: (1) “identif[y] ... the [intrastate tax] burden for which the State is attempting to compensate”; (2) show that “the tax on interstate commerce [is] roughly ... approximate [to]-but [does] not exceed—the amount of the tax on intrastate...