This article is part of MACo’s Policy Deep Dive series, where expert policy analysts explore and explain the top county policy issues of the day. A new article is added each week – read all of MACo’s Policy Deep Dives.

Nearly a decade after the United States Supreme Court issued its opinion in Comptroller of Maryland v. Wynne, SCOTUS is considering granting certiorari on a similar case involving the federal constitutional restrictions on state and local taxation.

Zilka v. Tax Review Board of the City of Philadelphia delves into the complexities of interstate taxation and challenges the way local taxes are credited against taxes paid to other states. Here, Conduit Street will explain the case, discuss its implications for local governments, and discuss how the Wynne decision contrasts with Zilka’s case.

The Zilka Case: An Overview

Diane Zilka is a Philadelphia, Pennsylvania, resident who worked in Wilmington, Delaware, from 2013 to 2016. During the years at issue, the taxpayer paid income taxes on the same income to two states and two local jurisdictions: Pennsylvania, Delaware, Wilmington, and Philadelphia.

Pennsylvania permits residents who work out of state and, therefore, owe taxes to another state to claim the amount of tax paid to that other state as a credit to offset the taxpayer’s Pennsylvania tax bill. Likewise, Philadelphia gives its residents a credit to offset income tax payments in different cities, such as Wilmington.

Zilka consequently claimed a credit for her Delaware tax (5%) to offset her Pennsylvania tax (3.07%). Since Pennsylvania has a lower tax rate than Delaware, the taxpayer could only apply this credit to the extent of her Pennsylvania tax of 3.07%, creating 1.93% of taxes paid to Delaware but not permitted as a credit against the taxpayer’s Pennsylvania taxes.

In addition to claiming a credit for the amount of Wilmington tax paid (1.25%) to offset her Philadelphia tax (3.92%), the taxpayer attempted to claim a credit against her Philadelphia tax for the 1.93% unused credit rejected at the state level. The Philadelphia Department of Revenue allowed the taxpayer’s credit for the 1.25% Wilmington tax to reduce her Philadelphia tax bill. However, it prohibited the application of the 1.93% unused credit from her Delaware tax as a credit against her Philadelphia taxes.

Zilka challenged Philadelphia’s tax policy, claiming that it violated the Commerce Clause of the US Constitution. This clause prevents states from creating unfair trade barriers and ensures interstate commerce is free from discriminatory or undue burdens. Zilka argued that Philadelphia’s refusal to provide tax credits for Delaware taxes created such a burden, as it effectively penalized her for working out of state.

The taxpayer appealed the Philadelphia Department of Revenue’s denial of her credit to the Tax Review Board of Philadelphia, claiming that she was entitled to this credit from Philadelphia since she owed 1.93% more in taxes than other Philadelphia residents who work entirely in-state, solely because of her interstate work. Zilka alleged that such a tax scheme infringed on interstate commerce, violating the US Constitution’s Commerce Clause.

The Tax Review Board denied her appeal, and the Court of Common Pleas, the Commonwealth Court of Pennsylvania, and the Pennsylvania Supreme Court all affirmed, holding that Philadelphia’s rejection of the taxpayer’s credit did not amount to double taxation and, therefore, was not an unconstitutional hindrance on interstate commerce.

Petitioner Seeks US Supreme Court Review

Zilka filed a petition for certiorari with SCOTUS on February 20, 2024. In the petition, Zilka argues that SCOTUS must hear the case because “Pennsylvania’s decision to treat Philadelphia as a separate sovereign from Pennsylvania would create a new loophole in the Constitution that conflicts with the Wynne decision and the laws of nearly every other state, and because what matters is how taxes work in practice, not the labels used by government officials.” The petition also argues that the prohibition of discriminatory burdens on interstate commerce includes local taxes.

SCOTUS has not yet agreed to hear the case. On June 10, 2024, the Court asked the Attorney General to file a brief setting out the United States’ views.

SCOTUS will grant review and hear oral arguments if at least four justices vote to do so. Assuming SCOTUS grants certiorari, the Court is unlikely to hear Zilka v. Tax Review Board of the City of Philadelphia until the fall of 2024.

Comparing Zilka to Wynne

The Zilka and Wynne cases both address the issue of interstate taxation and potential double taxation. However, despite their similarities, they differ significantly in their legal contexts, jurisdictions involved, and the broader implications of their outcomes.

Zilka argued Philadelphia’s policy was similar to the Maryland tax scheme SCOTUS invalidated as internally inconsistent in Wynne and that the Wynne decision holds that one must consider state and local taxes collectively because the relevant constitutional question is whether the tax scheme as a whole burdened interstate commerce.

In Wynne, the Court concluded that Maryland’s failure to credit against its county taxes the income taxes its residents paid to other states on income earned in those states failed the internal consistency test because if every state adopted the same scheme, taxpayers who earned income interstate would be taxed on the same income by the states where they lived and where they worked. By contrast, taxpayers who earned purely intrastate income would only pay taxes once.

However, the Pennsylvania Supreme Court concluded that local and state taxes need not be considered in the aggregate when determining whether a state’s tax policy survives under the Commerce Clause. It noted that the question was “a matter of first impression” in Pennsylvania and placed “paramount importance on the High Court’s decision in Wynne.”

Like the lower courts, it concluded that Wynne does not require aggregation; instead, Wynne considered the local tax along with the state tax only because the local tax “was essentially little more than a state tax masquerading as a local tax, given that the state imposed the tax via state legislation and the state’s comptroller collected the tax. Wynne, therefore, “sanctioned an ad hoc approach” to determine whether state and local taxes were de facto indistinguishable.

Applying that ad hoc approach, the majority concluded the Philadelphia Tax was not like the county tax in Wynne because it was “enacted by Philadelphia’s City Council and collected by the City’s Department of Revenue solely for the benefit of the City and its citizenry.” The majority also rejected the idea that state and local taxes are indistinguishable because local governments have jurisdiction to tax only if authorized by the state.

Critical Differences Between Zilka and Wynne

1. Jurisdictional Focus: Local vs. State Taxation

• Zilka: This case focuses on Philadelphia’s local tax policy. It examines whether a local government must provide tax credits for state taxes paid to another state.
• Wynne: This case deals with Maryland’s tax policy, including state and county levels. It examines whether a state must provide tax credits for taxes paid to other states to avoid double taxation.

2. Scope of Tax Policy Impact

• Zilka: The outcome of the Zilka case primarily affects the local tax policies of individual local governments, like Philadelphia, and how they handle residents who work out-of-state.
• Wynne: The Wynne decision has a broader impact on state tax policies across the US, setting a precedent that states must credit taxes paid to other states to prevent unconstitutional double taxation.

3. Legal Context and Precedent

• Zilka: The case did not result in a precedent-setting Supreme Court ruling. It upheld local autonomy, allowing local governments like Philadelphia to manage their tax policies independently.
• Wynne: The SCOTUS decision in Wynne set a significant precedent that affects how states and potentially local jurisdictions handle interstate income taxation. It emphasizes the need to prevent double taxation in accordance with the Commerce Clause.

4. Levels of Government Involved

• Zilka: This case involves a local government (Philadelphia) and its relationship with another state (Delaware). It questions whether local governments must adapt their tax policies based on the tax practices of other states.
• Wynne: Involves state government (Maryland) and the requirement to consider taxes paid to other states at the state and local (county) levels, thus impacting a broader range of taxpayers and jurisdictions.

5. Impact on Taxpayers

• Zilka: Affects individuals who live in one municipality and work in another state, potentially subjecting them to double taxation without recourse for credits from their local government.
• Wynne: This case addresses the financial burden on taxpayers subjected to double taxation by their state and local jurisdictions without credits for out-of-state taxes, affecting a larger pool of taxpayers with multi-state income

Implications for Local Governments

While Wynne addressed the need to credit both state and local taxes to prevent double taxation, Zilka’s case centers on local tax practices and whether local governments should credit state-level taxes. The Zilka ruling affirms Philadelphia’s assertion that the decision not to aggregate state and local taxes for credits falls within its rights as a local government to determine how it collects and credits taxes.

Wynne’s ruling had widespread implications for how states and localities handle tax credits. While specific to Philadelphia, Zilka’s case reinforces that local governments can manage their tax policies without being mandated to provide credits for taxes paid to other states.

However, if SCOTUS were to overturn the decision in the Zilka case, it could be detrimental to the autonomy, financial health, and operational efficiency of local governments:

Erosion of Local Tax Autonomy

Local governments could lose control over their tax policies, which are essential for addressing specific community needs and priorities. Overturning Zilka would potentially mandate local jurisdictions to provide tax credits for income taxes paid to other states, diminishing their ability to design tax systems that reflect local economic conditions and policy goals.

• Policy Flexibility: Local governments need the freedom to craft tax policies that meet their unique fiscal and social objectives. Requiring out-of-state tax credits could undermine this flexibility and force local policies to align with those of other jurisdictions, regardless of local needs.

Reduction in Revenue Streams

Mandating tax credits for out-of-state taxes could lead to significant revenue losses for local governments, which rely on income taxes to fund essential public services like education, infrastructure, and public safety. This financial strain could force local governments to cut services or increase other taxes to compensate for the shortfall.

• Fiscal Stability: Requiring local governments to provide credits for out-of-state taxes could jeopardize their fiscal stability, resulting in budget deficits and, ultimately, the ability to fund critical community services and investments.

Administrative Burden and Increased Costs

Providing credits for out-of-state taxes would increase the complexity of tax administration for local governments, leading to higher administrative costs and a greater likelihood of tax disputes. This added complexity could strain local resources and reduce efficiency.

• Operational Challenges: Managing a system that credits taxes paid to other states involves verifying tax payments and ensuring compliance with multiple jurisdictions’ tax rules, which can be costly and resource-intensive for local tax authorities.

Precedent Setting and Legal Uncertainty

Overturning Zilka could set a legal precedent that requires local governments nationwide to adjust their tax policies in response to interstate tax dynamics, which could lead to legal uncertainty and increased litigation as local jurisdictions navigate the complexities of complying with new legal standards imposed by higher courts.

• Legal Precedents: A ruling overturning Zilka might create an endless stream of litigation, leading to an unpredictable regulatory environment that complicates local governments’ long-term planning and fiscal management.

Equity and Fairness Issues

Requiring local governments to provide tax credits for out-of-state taxes could create perceptions of unfairness among residents, particularly those who do not work out of state and thus do not benefit from such credits. This could lead to discontent and inequity in the local tax system.

• Taxpayer Equity: Ensuring that tax policies are fair and equitable for all residents is a core principle of good governance. Mandating out-of-state tax credits might benefit a specific group of taxpayers while placing a disproportionate burden on others who do not receive similar tax benefits.

Conclusion

The Zilka case is a pivotal example of the importance of local autonomy in tax policy. The ruling underscores local governments’ need to control local tax revenues and policies, ensuring they can provide essential services and meet their budgetary needs.

The ruling supports fair and consistent tax practices that promote fiscal stability and policy flexibility by upholding local governments’ autonomy. However, county leaders must recognize the potential ramifications of a Supreme Court decision that could mandate local tax credits for out-of-state taxes. Such a ruling could disrupt local revenue streams, complicate tax administration, and impose significant financial burdens on local communities.

Stay tuned to Conduit Street for more information.