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Jamie C. Yesnowitz
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On Jan. 7, 2022, the Pennsylvania Commonwealth Court ruled that a Philadelphia resident taxpayer who worked for a Wilmington, Delaware based employer was not entitled to a credit against her Philadelphia Wage Tax (City Wage Tax) liability for state income tax paid to Delaware for the 2013-2016 tax years.1
The Court determined that Philadelphia was justified in granting a credit for local earned income tax (EIT) paid to Wilmington, while declining to grant a credit for state income taxes paid, finding such policy to be constitutional on the basis that the state and local income taxes are levied separately.
The taxpayer was a resident of Philadelphia, Pennsylvania, but worked full-time in Wilmington, Delaware. In 2017, the taxpayer filed a petition with the Philadelphia Department of Revenue to refund a portion of her City Wage Tax paid from 2013-2016. During these tax years, the taxpayer’s employer withheld four state and local taxes: City Wage Tax; Wilmington EIT; Pennsylvania Personal Income Tax (Pennsylvania PIT); and Delaware Personal Income Tax (Delaware PIT). The taxpayer claimed a credit for the portion of Delaware PIT (imposed at a 5% rate) that offset the Pennsylvania PIT (imposed at a 3.07% rate). The taxpayer paid PIT to Delaware and took a credit against the full balance of her Pennsylvania PIT liability. The taxpayer also paid City Wage Tax at the 3.92% resident rate and took a credit for the Wilmington EIT paid at a 1.25% rate.2
The taxpayer claimed a credit for the remaining 1.93% of Delaware PIT paid to offset much of her remaining City Wage Tax liability. The Department allowed a credit for Wilmington EIT paid, thereby reducing the taxpayer’s Philadelphia Wage Tax effective rate to 2.67% (3.92% - 1.25%). However, the Department disallowed the remaining portion of the credit claimed for PIT paid to Delaware. 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 Commonwealth Court.
Commonwealth Court decision
At Commonwealth Court, the taxpayer argued that Philadelphia’s refusal to allow the remaining Delaware PIT credit to offset her City Wage Tax liability violated the Commerce Clause of the U.S. Constitution. To determine whether the policy violated the Commerce Clause, the Court applied the four-part test from the U.S. Supreme Court’s decision in Complete Auto Transit, Inc. v. Brady
Specifically, the taxpayer claimed that Philadelphia’s crediting policy violated the fair apportionment and discrimination prongs of Complete Auto
. First, the taxpayer argued the tax was not fairly apportioned because it resulted in the double taxation of her income, and by not allowing the Delaware PIT credit to offset the City Wage Tax, the policy did not meet the internal and external consistency tests used to examine fair apportionment issues. Second, the taxpayer claimed that the denial of a credit for PIT paid to Delaware is discriminatory in that it resulted in her paying more tax than those taxpayers working in-state.
While the Commerce Clause disallows double taxation, the Court ruled that the taxpayer’s income was not being doubly taxed because the taxpayer is not paying more than one local or state tax. Recognizing that the taxpayer pays more City Wage Tax than similar intrastate taxpayers, the Court reasoned that it was the taxpayer’s choice to work in Delaware, which charges a higher PIT rate than Pennsylvania. Finding that the taxpayer paid City Wage Tax at the same rate as other intrastate residents, the Court concluded that this did not amount to double taxation despite the uncredited balance of Delaware PIT paid.
Next, the Court applied Complete Auto
to consider whether Philadelphia’s policy discriminated against interstate commerce. Reviewing U.S. Supreme Court case law, the Court noted that the taxing policy must be both internally and externally consistent.4
First, the Court determined that Philadelphia’s crediting policy satisfied the internal consistency test, which looks at the structure of a particular state or local tax scheme to determine whether there are situations where taxpayers are paying tax in more than one state or local jurisdiction in a way that would discriminate against interstate commerce. Here, the Court determined that the City Wage Tax policy met the internal consistency test because the taxpayer received a credit for the taxes paid in similar jurisdictions. In other words, if every jurisdiction levied a tax similar to that of Philadelphia, residents would receive a credit for local tax paid to other jurisdictions and would be subject to the same local tax rate.
Next, the Court ruled that the taxpayer had a sufficient connection with Philadelphia to satisfy the external consistency test, which focuses on whether a tax is “fairly attributable to economic activity within the taxing State.”5
In this case, the Court reasoned that Philadelphia fairly apportions City Wage Tax due to the taxpayer by providing a credit for tax owed to Wilmington, and therefore was not taxing all of the taxpayer’s income. The Court also noted that Philadelphia’s provision of municipal benefits and services to residents provides “sufficient economic justification” for taxing income earned outside the state.
The Court then considered whether Philadelphia’s policy discriminated against interstate commerce. Under Complete Auto
, a state tax may not discriminate against foreign companies competing with local business or discriminate against commercial activity occurring outside the state.6
Here, the taxpayer received a credit against her City Wage Tax liability for income tax paid to Wilmington. According to the Court, such credit ensured that the taxpayer was not subject to double taxation, resulting in no disparate treatment or discrimination between the taxpayer and other resident taxpayers.
Finally, the Court distinguished the taxpayer’s facts from those in Comptroller of the Currency v. Wynne
, a 2015 U.S. Supreme Court decision considering the constitutionality of Maryland’s personal income tax (PIT) structure.7
, the 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.8
to be instructive but factually distinguishable, the Court observed that the decision did not compel Philadelphia to permit an additional credit for dissimilar state taxes paid such as Delaware PIT. In particular, the Court noted that the local portion of Maryland’s PIT was actually a “state tax” because it was “administered, adopted, mandated, and collected by the state.” Unlike Maryland’s PIT, the Court observed, the City Wage Tax is purely a municipal tax. Therefore, the Court determined that Philadelphia’s taxing policy did not violate Wynne
because the City offers a credit for municipal taxes paid to similar local jurisdictions such as Wilmington. Concluding that Philadelphia’s crediting policy did not amount to double taxation or an otherwise discriminatory practice, the Court affirmed the trial court’s order denying the credit.
Although this decision was not reported and may be of limited precedential value, the Zilka
case provides the first insight into how Pennsylvania courts may evaluate the constitutionality of Philadelphia’s controversial Wage Tax crediting policy. The Court sustained the policy on the basis that state and local income taxes are distinct levies and that the City was not required to provide a credit for different taxes administered by a state taxing authority. The Court concluded that there was no double taxation in this case because the taxpayer did not pay income tax twice on her interstate income. Rather, the taxpayer paid Wage Tax at a higher rate due to the difference in income tax rates between Pennsylvania and Delaware, due to the taxpayer’s choice to work in Delaware.
Under the Court’s analysis of the Wynne
decision, allowing the taxpayer to claim a credit only for corresponding local tax paid was sufficient for the City’s crediting policy to withstand Commerce Clause scrutiny. An important distinction for the Court was the fact that the local portion of Maryland’s PIT is administered by the state. However, Maryland’s counties do have some discretion over the imposition of and the rate of local income tax imposed. Despite the apparent factual differences between the Wynne
cases, in both cases taxpayers working outside their resident state (or deriving income from out-of-state sources) pay more tax than their resident counterparts who do not. While the factual distinctions carried enough weight for the Court to uphold Philadelphia’s policy, one question on appeal is whether such distinctions are sufficient to satisfy Commerce Clause requirements.
It should be noted that on Feb. 4, 2022, the taxpayer appealed this decision to the Pennsylvania Supreme Court, which has the discretion to accept or reject the appeal. The ultimate outcome of the case may have important implications not only for Philadelphia residents who commute outside the state, but also for those residents working remotely for an out-of-state employer. Pennsylvania, Philadelphia, Delaware, and Wilmington all follow some form of a “convenience of the employer” rule, under which 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 that is located in the taxing jurisdiction.9
As a result, Philadelphia residents working remotely for an employer based in Delaware (and Wilmington) may be subject to Delaware PIT (and Wilmington EIT) if they are not required to telecommute in a post-pandemic environment.10
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