The Utah Supreme Court refused to extend protections of the foreign commerce clause to individuals. That can’t be right, can it?
In light of the landmark U. S. Supreme Court rulings in Wynne and Wayfair and some important dicta in Kaestner Trust (an analogous Due Process Clause case), the Utah Supreme Court’s recent ruling in Steiner v. Utah State Tax Commission, 2019 UT 47 (8/14/19) raises a direct challenge to several of the fundamental principles the U. S. Supreme Court laid down in its recent Commerce Clause decisions. Could this be the next big state and local tax case the High Court should take? The authors think so.
The Utah resident taxpayers are husband and wife, shareholders (directly or indirectly) of an LLC that elected S corporation status and does business throughout the world. On their Utah individual income tax returns, in addition to claiming a credit for income taxes paid to other states under Utah Code Section 59-10-1003, they also claimed an equitable adjustment under Section 59-10-115 by excluding all the S corporation’s foreign income from their Utah taxable income. Utah law does not provide a credit for foreign taxes. The Utah State Tax Commission disallowed the adjustment. The taxpayers appealed to the Utah district court in Salt Lake City that also sits as the state’s Tax Court.
The Tax Court, on cross-motions for summary judgment, vacated the Tax Commission’s ruling as to the latter issue and reinstated the taxpayers’ equitable adjustment, finding that the state’s failure to provide some adjustment for the taxes paid to foreign countries violated the U.S. Constitution’s Foreign Commerce Clause, concluding that the principles enunciated in Wynne apply equally to income earned in foreign commerce.
The Utah Supreme Court would have none of this, and in a bold and often biting 5-0 opinion raised a host of questions that seem to directly challenge certain aspects of the U.S. Supreme Court’s ruling in Wynne, almost begging the High Court to address yet again Commerce Clause issues.
The Utah Supreme Court’s finding that the Foreign Commerce Clause applies only to C corporations because the U.S. Supreme Court has never expressly extended it to individuals (Steiner at 15) seems to contradict the fundamental principle of Wynne: regardless of the type of taxpayer (e.g., corporation or individual) or whether he or she is a resident of the state, the Commerce Clause applies. The Utah Tax Court didn’t seem to have any problem with connecting the dots in concluding that the principles articulated in the U.S. Supreme Court’s domestic Commerce Clause jurisprudence apply equally to the Foreign Commerce Clause, and individuals are protected to the same extent as corporations. The Tax Court buttressed its position by pointing to the statement in Kraft that foreign commerce is afforded even “greater protection from discrimination than interstate commerce.”
Citing what appears to be dicta in the Wynne decision, in which the majority suggested that a state could satisfy the internal consistency test by simply taxing only the income of its residents, the Utah Supreme Court surprisingly concluded that the external consistency test is now dead, at least as to individuals: “Utah’s tax regime need not satisfy the external consistency test”. Perhaps the High Court saw no violation of external consistency at all and therefore chose not to mention it?
Since the U.S. Supreme Court didn’t expressly apply the Complete Auto four prong test in Wynne, the Utah Court concluded that “the continuing vitality of the Complete Auto test is thus in serious doubt.[footnote omitted]” (Steiner at 10.) Such a sweeping statement seems to ignore the Wayfair majority’s clear reminder that the Complete Auto test is the “now-accepted framework for state taxation.” (Wayfair at Slip Op. pg. 7.)
With an assessment of over $1.3 million, and such a bold attack on both Wynne and the scope of the Foreign Commerce Clause, it seems probable that the taxpayers will file a cert. petition with the U.S. Supreme Court. In sum, we think the Utah Tax Court got it right, and with all due respect, the Utah Supreme Court got it very wrong, although we empathize with that Court’s frustration over the sometimes indecipherable state tax jurisprudence of the U.S. Supreme Court. Truly a puzzling outcome, but a case to watch over the coming months.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Steven Wlodychak is a Principal and State and Local Tax Leader at the EY Center for Tax Policy and a member of the Bloomberg Tax & Accounting State Tax Advisory Board.
The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or any other member firm of the global Ernst & Young organization.
Bruce Ely is a partner in the multistate law firm of Bradley Arant Boult Cummings LLP in its Birmingham, Alabama office and a long-time member of the Bloomberg Tax & Accounting State Tax Advisory Board.
Bruce and Steve received the Bloomberg Tax & Accounting State Tax Co-Authors of the Year award in December 2017 for their work on Bloomberg Tax’s Pass-through Entity Navigator (PTEN).
Thanks to our friend and fellow Bloomberg Tax & Accounting State Tax Advisory Board member, Professor Rick Pomp, for his helpful insights, although the authors take full responsibility for any errors.
© September 9, 2019. Steven N. Wlodychak/Bruce P. Ely. All rights reserved.