U.S. Supreme Court denies review of Philadelphia wage tax challenge

 

On January 13, 2025, the U.S. Supreme Court issued an order declining to review a Philadelphia resident taxpayer challenge to the City of Philadelphia’s Wage Tax (City Wage Tax) policy denying a credit for personal income tax paid to other states.1 The denial leaves in place a November 2023 ruling by the Pennsylvania Supreme Court (Court) upholding the City’s policy of providing only a credit for Wilmington Earned Income Tax (EIT) paid against the taxpayer’s City Wage Tax liability.2 In a 3-2 decision, the Court had concluded that the City is not obligated to provide a credit for state income tax paid to Delaware because the policy did not discriminate against interstate commerce.

 

 

 

Background and procedural history

 

For the tax years at issue, the taxpayer was a Philadelphia resident and worked full-time in Wilmington, Delaware. In 2017, the taxpayer filed a refund petition with the Philadelphia Department of Revenue (Department) for a portion of her City Wage Tax from 2013 to 2016. During that period, the taxpayer’s employer withheld four different state and local income taxes on her wages: City Wage Tax (3.922% resident rate), Wilmington EIT (1.25% rate), Pennsylvania Personal Income Tax (PIT) (3.07% rate) and Delaware Personal Income Tax (Delaware PIT) (5% rate). The availability of credits for taxes paid substantially reduced what would have been an aggregate tax rate of over 13%. The taxpayer claimed a credit for the portion of Delaware PIT that completely offset the Pennsylvania PIT liability, resulting in 1.93% (5% – 3.07%) of remaining Delaware PIT. The taxpayer also paid City Wage Tax and took a credit for the Wilmington EIT, resulting in 2.672% (3.922% – 1.25%) of remaining City Wage Tax.[1] Both of these credits were respected by the Department.

 

However, the taxpayer also claimed a credit for the remaining 1.93% Delaware PIT paid to offset her remaining 2.672% City Wage Tax liability. The Department disallowed this credit claimed for the remaining Delaware PIT. The taxpayer appealed to the Philadelphia Tax Review Board and the Philadelphia County Court of Common Pleas, which both upheld the Department’s decision to disallow the remaining Delaware PIT credit. The taxpayer appealed the decision to the Pennsylvania Commonwealth Court.

 

 

Commonwealth Court decision

 

On appeal, the Commonwealth Court affirmed the trial court and sustained the City’s policy.4 The court concluded that the taxpayer’s income was not subject to double taxation because the taxpayer paid City Wage Tax at the same rate as other intrastate residents, and never paid more than one local and state tax at a time. The court also determined that the City policy did not discriminate against interstate commerce because the taxpayer received a credit for taxes paid in similar jurisdictions, including Wilmington. Finally, the court determined that the policy did not violate the U.S. Supreme Court’s decision in Comptroller of the Treasury v. Wynne, a 2015 ruling considering the constitutionality of Maryland’s PIT structure.5 In particular, the Commonwealth Court found Wynne to be distinguishable from the taxpayer’s facts because the local tax at issue in Wynne was actually a state tax. The Maryland tax was adopted, administered and collected by the state, even though it varied according to the county in which the taxpayer resided. In contrast, the Commonwealth Court viewed the City Wage Tax as a purely municipal tax that was appropriately credited with the Wilmington EIT. For these reasons, the court concluded that the City’s crediting policy did not amount to double taxation or an otherwise discriminatory practice.

 

The taxpayer appealed the decision to the Court, arguing that the City’s policy discriminated against interstate commerce in violation of the Commerce Clause of the U.S. Constitution. The Court granted review and heard oral arguments in March 2023.

 

 

 

Pennsylvania Supreme Court decision

 

 

Aggregation of state and local taxes

 

In weighing the taxpayer’s constitutional claims, the Court first considered the issue of whether state and local taxes must be aggregated in analyzing a tax scheme under the Commerce Clause. The majority found the Wynne decision to be particularly instructive on the aggregation issue. In doing so, the Court distinguished the City Wage Tax from the Maryland tax scheme at issue in Wynne. In the Court’s view, Maryland’s county tax was a state tax “masquerading” as a local tax because it was enacted by the state and collected by the Maryland Comptroller. In contrast, the City Wage Tax was enacted by the Philadelphia City Council and collected by the City Department of Revenue for the benefit of the City and its residents. In reviewing its own precedents on the subject, the Court rejected the taxpayer’s arguments that the City is a creature of the state and derives its taxing authority from the Commonwealth.

 

The Court next rejected the taxpayer’s alternative arguments supporting the aggregation of the City Wage Tax and Pennsylvania PIT in considering a Commerce Clause violation. In doing so, the Court considered three cases supporting the taxpayer’s position that invalidated other state tax schemes because they failed to offer credits for local taxes paid out of state. In the first case, Arizona Department of Revenue v. Arizona Public Service Company, the court interpreted a state statute as requiring Arizona to provide tax credits for state and local sales and use taxes paid out-of-state.6 The Court reasoned that the Arizona case had limited value in support of aggregating state and local taxes because state law primarily governed the outcome of the case rather than the Commerce Clause.

 

Next, the Court considered General Motors Corp. v. City & County of Denver, in which the Colorado Supreme Court struck down Denver’s use tax policy, which did not provide a credit for tax paid to other jurisdictions.7 The Court ultimately rejected the application of General Motors to the present case because, in the Court’s review, the Colorado Supreme Court provided insufficient analysis to support the conclusion that state and local taxes must be aggregated for Commerce Clause purposes.

 

Finally, the Court considered the case of Matkovich v. CSX Transportation, Inc.8 In Matkovich, the West Virginia Supreme Court determined that the state did not provide a credit for local motor fuel taxes paid to other local jurisdictions, and the court relied on Wynne, Arizona Department of Revenue, and General Motors to conclude that such policy violated the Commerce Clause. Finding that Matkovich relied on cases which the Court already rejected as inapplicable, the Court likewise concluded that Matkovich did not apply.

 

Finding that the three out-of-state cases advanced by the taxpayer had little persuasive value, the Court determined that the City Wage Tax operates as a “purely local tax,” reasoning that it was promulgated by the City Council and is collected by the Department for the benefit of the City and its residents. Accordingly, the Court declined to consider the City Wage Tax in the aggregate with the Pennsylvania PIT in undertaking a Commerce Clause analysis.

 

 

Commerce Clause analysis

 

Viewing the City Wage Tax on its own, the Court next applied the four-part test in Complete Auto Transit v. Brady to determine whether the tax passes Commerce Clause scrutiny.9 In particular, the taxpayer argued that the policy was not fairly apportioned and discriminated against interstate commerce.10 Assuming all other jurisdictions adopted identical taxes with similar rates, the Court reasoned that the tax scheme is internally consistent because the City imposes “a consistent tax on all residents and provides the necessary credit against similar out-of-state local taxes paid by them.” Any additional tax paid resulted from Delaware’s higher PIT rate of 5%.

 

The Court likewise found that the tax policy satisfied the external consistency test because the tax is based on residency and the City’s provision of municipal benefits and services to residents provides “sufficient economic justification” for the imposition of the tax. The Court agreed with the Commonwealth Court that the City avoided a double taxation issue by providing a credit for local tax paid to Wilmington. In the majority’s view, “the City should not be required to subsidize Delaware’s higher tax rate when it already offsets its Wage Tax by crediting taxpayers for analogous local taxes paid outside of its jurisdiction.”

 

For these reasons, the Court concluded that the City Wage Tax policy was fairly apportioned and did not discriminate against interstate commerce, thus finding no Commerce Clause violation. Accordingly, the Court affirmed the Commonwealth Court in upholding the policy.

 

 

 

Concurring and dissenting opinions

 

In a concurring opinion, one justice agreed with the majority’s decision to uphold the City Wage Tax policy. While the justice agreed with the majority that Wynne does not require the aggregation of state and local taxes, the justice noted that the U.S. Supreme Court has frequently adjusted and revised its interpretation of the Commerce Clause, and that the Court would be likely to modify its precedent in this area in the future. As such, the justice wrote separately to note that the case “may be worthy of certiorari so that the [U.S. Supreme] Court can consider whether the internal consistency test should be applied as a state-level inquiry.”

 

In a dissenting opinion, one justice argued that the failure to aggregate state and local taxes results in discrimination against interstate commerce. The justice disagreed with the majority’s analysis of the Wynne decision, noting that the U.S. Supreme Court did not consider Maryland’s county tax to be a local tax. In the justice’s view, the two cases presented different issues, making Wynne persuasive but not controlling. Unlike the majority, the dissenting justice was persuaded by the three out-of-state cases advanced by the taxpayer, supporting the case that the City Wage Tax must be considered as part of Pennsylvania’s overall income tax scheme. Viewing the City crediting policy from an economic perspective, the justice concluded the practice of disallowing a credit for additional non-credited state taxes discriminates against interstate commerce by “providing a direct commercial advantage to those who live and work in Philadelphia; it thus violates the dormant Commerce Clause.” 

 

 

 

Appeal to U.S. Supreme Court

 

In February 2024, the taxpayer filed a petition for a writ of certiorari with the U.S. Supreme Court, requesting review of the Court’s decision. In particular, the taxpayer argued that the Court’s decision created a split between the states over whether state and local taxes should be aggregated in analyzing their constitutionality. In June 2024, the U.S. Supreme Court invited the U.S. Solicitor General to file a brief expressing the views of the United States on whether the U.S. Supreme Court should take the case. On December 9, 2024, the Solicitor General responded by filing a brief urging the U.S. Supreme Court to deny review of the case. The Solicitor General argued that the Court correctly determined that the City Wage Tax does not violate the internal consistency test of Complete Auto or conflict with any other decisions of the U.S. Supreme Court, and therefore, no further review is warranted. The U.S. Supreme Court ultimately denied review of the case in an order issued in Jan. 13, 2025.

 

 

 

Commentary

 

The U.S. Supreme Court’s refusal to review the Zilka decision does not resolve the questions concerning the proper analysis of state and local tax crediting systems that are challenged for constitutional reasons. In upholding the City’s crediting policy, the Pennsylvania Supreme Court relied heavily on the Wynne decision in reaching the the conclusion that state and local taxes do not have to be aggregated in analyzing the constitutionality of the City Wage Tax. However, the Court was careful to distinguish Wynne from the present case given Philadelphia’s independent administration of the tax, and the amount of control that Philadelphia exercised over the tax. While the Court concluded that such distinctions were enough to view the City Wage Tax separately from a state tax, the Court discounted the fact that the City itself is, in substance, an extension of the Commonwealth and derives its taxing authority from the state.

 

Ultimately the Zilka decision did not provide clear rules outlining the instances in which it is appropriate to aggregate state and local taxes, including the amount of control a local government has over the tax, or whether aggregation should be considered at all in undertaking a constitutional analysis. As the taxpayer argued and the concurring and dissenting justices noted in their opinions, the decision creates a split among the states over whether state and local taxes should be aggregated in analyzing their constitutionality. The issue remains ripe for resolution by the U.S. Supreme Court, especially since the Wynne decision says little about aggregation. Meanwhile, the Zilka decision may give other states license to create local tax regimes similar to the City Wage Tax in a manner that will not require the provision of a full credit for taxes paid to other states. If enacted, such taxes are likely to be challenged and the same disputes could find their way back to the U.S. Supreme Court in a different form.

 

In the longer term, the Zilka decision complicates the state and local tax treatment of cross-border employment in the age of hybrid work. While the fact pattern of employees living in one jurisdiction and working in another is not a new one, remote work may create more common instances of double taxation for those jurisdictions following a “convenience of the employer” rule. Under this rule, an employee’s income is sourced to the taxing jurisdiction if the employee works remotely for their own convenience, rather than as a requirement of their employer. Given that Pennsylvania, Philadelphia, Delaware and Wilmington all follow some form of a convenience rule, an employee working remotely in one jurisdiction for an employer located in another may be subject to additional tax. The question then becomes whether a limited credit for taxes paid to another jurisdiction creates additional double taxation issues implicating the same Commerce Clause concerns raised in Zilka.

 

 


1 Zilka v. City of Philadelphia, Tax Review Board, U.S. Supreme Court, No. 23-914, certiorari denied Jan. 13, 2025.
2 Zilka v. City of Philadelphia, Tax Review Board, 304 A.3d 1153 (Pa. 2023).
3 Noting that slight income tax rate variations exist from year to year, the Court referred to the tax rates that were in place during the 2014 tax year for purposes of its decision, which were also utilized by the Commonwealth Court.
4 Zilka v. City of Philadelphia Tax Review Board, 272 A.3d 991 (Pa. Commw. Ct. 2022). For further discussion, see GT SALT Alert: Pennsylvania rules on Philly wage tax credit case.
5 575 U.S. 542 (2015). In Wynne, the U.S. Supreme Court ruled that Maryland’s PIT scheme violated the Commerce Clause due to the state’s failure to provide a credit for the local portion of its PIT for taxes paid to other states.
6 934 P.2d 796 (Ariz. Ct. App. 1997).
7 990 P.2d 59 (Colo. 1999).
8 793 S.E.2d 888 (W. Va. 2016).
9 430 U.S. 274 (1977). Under Complete Auto, a state or local tax does not burden interstate commerce when the tax: (i) is applied to an activity with substantial nexus to the taxing state; (ii) is fairly apportioned; (iii) does not discriminate against interstate commerce; and (iv) is fairly related to the services provided by the state.
10 Under the fair apportionment prong of Complete Auto, a tax must be both (i) internally consistent, meaning that interstate commerce is not burdened if every jurisdiction imposed an identical tax; and (ii) externally consistent, where a tax must be fairly related to the economic activity occurring in the state.

 

 
 

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