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Zilka v. Tax Rev. Bd., 2023 Pa. LEXIS 1584, 2023 WL 8102749 (S. Ct. November 22, 2023) (Todd, C.J.)

In this appeal by allowance, we consider whether the City of Philadelphia (the “City” or “Philadelphia”) unconstitutionally discriminated against interstate commerce by subjecting a Philadelphia resident who worked exclusively out of state to its wage tax (the “Philadelphia Tax”), and allowing her credit against that tax only for the local income tax she paid to another jurisdiction, while declining to afford her additional credit for the out-of-state income tax she paid. In conjunction with this overarching issue, we must determine whether, for purposes of the dormant Commerce Clause analysis implicated herein, state and local taxes must be considered in the aggregate. For the reasons that follow, we conclude that state and local taxes need not be aggregated in conducting a dormant Commerce Clause analysis, and that, ultimately, the City’s tax scheme does not discriminate against interstate commerce. Accordingly, we affirm the order of the Commonwealth Court.

Okla. Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 179, 115 S. Ct. 1331, 131 L. Ed. 2d 261 (1995)). Notably, the high Court has explained that the crux of the dormant Commerce Clause is that a state “may not tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State,” id. (quoting Armco Inc. v. Hardesty, 467 U.S. 638, 642, 104 S. Ct. 2620, 81 L. Ed. 2d 540 (1984)), nor may it “impose a tax which discriminates against interstate commerce either by providing a direct commercial advantage to local business, or by subjecting interstate commerce to the burden of ‘multiple taxation,'” id. at 549-50 (quoting Nw. States Portland Cement Co. v. Minnesota, 358 U.S. 450, 458, 79 S. Ct. 357, 3 L. Ed. 2d 421 (1959)). However, where alleged taxation disparities stem from the combined effect of two otherwise lawful income tax schemes, the Court has manifestly determined that there is no discrimination against interstate commerce. See Moorman Mfg. Co. v. Bair, 437 U.S. 267, 279, 98 S. Ct. 2340, 57 L. Ed. 2d 197 (1978) (observing that “[t]he prevention of duplicative taxation[] . . . would require national uniform rules for the division of income,” which is a task solely in the province of Congress).
Significantly, in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 97 S. Ct. 1076, 51 L. Ed. 2d 326 (1977), the high Court crafted a four-part test for determining whether a state or local tax unconstitutionally burdens interstate commerce. Under this test, a tax does not violate the dormant Commerce Clause if it: (1) is applied to an activity with a substantial nexus to the taxing state; (2) is fairly apportioned; (3) does not discriminate against interstate commerce; and (4) is fairly related to the services provided by the state. Id. at 279. Relevant to the instant appeal, to determine whether a tax is fairly apportioned, a court must assess whether the tax is internally and externally consistent. The high Court has explained that internal consistency is met “when the imposition of a tax identical to the one in question by every other State would add no burden to interstate commerce that intrastate commerce would not also bear.” Jefferson Lines, 514 U.S. at 185. Conversely, an internally inconsistent tax demonstrates that a state “is attempting to take more than its fair share of taxes from the interstate transaction, since allowing such a tax in one State would place interstate commerce at the mercy of those remaining States that might impose an identical tax.” Id. (citation omitted). As for external consistency, a court must examine “the economic justification for the State’s claim upon the value taxed, to discover whether a State’s tax reaches beyond that portion of value that is fairly attributable to economic activity within the taxing State.” Id. (citation omitted).

Relevant to the instant appeal, in 2015, the high Court grappled with these issues in Wynne, supra. Therein, the Court examined Maryland’s tax scheme, under which Maryland required its residents to pay a “state” income tax which was set at a graduated rate, and a “county” income tax, the rate of which varied by county for wages earned both in and out of state, and additionally imposed upon nonresidents a “special nonresident” tax on their income earned in Maryland. Wynne, 575 U.S. at 545-46. While Maryland allowed residents who earned income out of state a credit against the state tax, it did not permit them any credit against the county tax. Id. at 546. Critically, the high Court determined that, “[d]espite the names that Maryland ha[d] assigned to these taxes, both [were] State taxes,” noting that “both [were] collected by the State’s Comptroller of the Treasury.” Id. (citation omitted).

As an initial matter, we emphasize that the question of aggregation for purposes of a dormant Commerce Clause analysis is a matter of first impression for this Court.

The Philadelphia Tax is readily distinguishable from the county tax at issue in Wynne, as the latter was enacted by the State of Maryland and collected by Maryland’s comptroller, whereas the Philadelphia Tax was enacted by Philadelphia’s City Council and is collected by the City’s Department of Revenue solely for the benefit of the City and its citizenry. In light of this stark contrast, we reject Appellant’s argument that Wynne mandates that we aggregate the Philadelphia Tax with the PIT in discerning whether it violates the dormant Commerce Clause.

We likewise reject Appellant’s claim that the City was required to aggregate the Philadelphia Tax and the PIT because local governments, such as the City, are creatures of statute, which derive taxation authority solely from the legislative enactments of our General Assembly. It is axiomatic that “[t]he validity of the taxing ordinance does not depend upon whether the tax is regarded in a legal sense as a state or local tax,” given that “[a]ll taxes in Pennsylvania levied by municipal and quasi municipal corporations must, of course, be authorized by the legislature.” McClelland, 57 A.2d at 848. Indeed, our Court has recognized that, “[i]n that sense, therefore, all [taxes] may be considered state taxes.” Id. (emphasis original). Nevertheless, although our Court has acknowledged that, in a sense, state and local taxes are indistinguishable, as both are authorized by state legislation, we have also stressed that “[s]tate taxes stand on a different basis from local levies.” Nothing in the high Court’s teachings, nor in our own jurisprudence, stands for the premise that state and local taxes are broadly indistinguishable, much less supports Appellant’s conclusion that state and local taxes must be aggregated for purposes of a dormant Commerce Clause analysis.

The appropriate question, which we address below, is whether an individual would be subject to double taxation if all states and local taxing authorities were to adopt the same taxes and crediting systems as Pennsylvania and Philadelphia. See Wynne, 575 U.S. at 562.

We conclude that the Philadelphia Tax was enacted, and operates, as a purely local tax, given that it was promulgated by Philadelphia’s City Council and is collected by the Department for the sole benefit of the City and its residents; as a result, we will not consider these state and local taxes in the aggregate in applying the Complete Auto test.

Having determined that the Philadelphia Tax and the PIT should be treated as discrete taxes, we must consider whether the City’s tax scheme discriminates against interstate commerce. We conclude, as did the Commonwealth Court, that the Philadelphia Tax and the City’s corresponding crediting system satisfy the test set forth in Complete Auto.

As explained above, Appellant challenges the Philadelphia Tax under two prongs of the Complete Auto test: first, she contends that the City’s tax scheme is not fairly apportioned; and second, she avers that the tax scheme discriminates against interstate commerce. In assessing whether the tax scheme is fairly apportioned, we must determine whether it is internally and externally consistent. Once more, the high Court’s decision in Wynne provides clear guidance with respect to this endeavor.

To briefly reiterate, the Wynne Court found that Maryland’s tax scheme was not internally consistent because, if every state adopted the three taxes at issue (the county tax, the state tax, and the special non-resident tax) and adopted Maryland’s system of not crediting against those taxes, residents who paid income tax to out-of-state jurisdictions would incur double taxation. Wynne, 575 U.S. at 565. The Court stressed that such double taxation was “not simply the result of [the tax scheme’s] interaction with the taxing schemes of other States,” but, instead, emanated from inherent discrimination contained within the scheme. Id. (citations omitted). Pertinently, in declaring Maryland’s tax scheme unconstitutional, the Court explained that “Maryland could remedy the infirmity in its tax scheme by offering, as most States do, a credit against income taxes paid to other States,” which would vindicate the tax scheme under the internal consistency test. Id. at 568 (citation omitted).

We must assume that all local taxing jurisdictions adopt the Philadelphia Tax rate of 3.922% and the City’s corresponding practice of crediting taxpayers for local taxes paid to other jurisdictions. In this scenario, April, who lives in State A and works exclusively in State A, would pay 3.922% once to State A, while Bob, who lives in State A but works in State B, would also pay only 3.922% once, to State B, because State A would permit him a credit against its own tax. Thus, both in-state and out-of-state taxpayers would yield the same tax obligation. The same remains true even if we add the Commonwealth’s state tax to this hypothetical, as each taxpayer would simply incur an additional state tax obligation of 3.07% consistent with the PIT and the Commonwealth’s corresponding practice of offsetting the PIT with state taxes paid elsewhere. Accordingly, when the internal consistency test is properly applied to the Philadelphia Tax and the PIT, along with the corresponding tax credits permitted by the City and the Commonwealth, it is evident that any remaining “disparate incentives to engage in interstate commerce” stem solely from “the interaction of two different but nondiscriminatory and internally consistent schemes.” Id. at 562 (citations omitted); see Steiner, 449 P.3d at 197 (finding that, because Utah offered a tax credit for out-of-state taxes, it was internally consistent and compatible with Wynne); Goggin v. State Tax Assessor, 2018 ME 111, 191 A.3d 341, 347 (Me. 2018) (“Here, the Maine statute expressly allows a credit for the payment of individual income taxes to other states . . . and therefore does not run afoul of Wynne.”).

Hence, the Commonwealth Court correctly determined that any excess taxes paid by Appellant were simply the result of Delaware’s higher income tax rate of 5%, rather than any inherent discrimination contained in the Philadelphia Tax or the City’s practice of offsetting its tax with credits paid only to local taxing jurisdictions.

Certainly, 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, we find that the Philadelphia Tax meets the internal consistency test, and that, relatedly, the tax is not discriminatory under the third prong of the Complete Auto test 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. See Armco Inc., 467 U.S. at 644 (commingling consideration of the internal consistency test and the discrimination prong of the Complete Auto test because “[a] tax that unfairly apportions income from other States is a form of discrimination against interstate commerce”).

Additionally, we find that the Philadelphia Tax meets Complete Auto’s external consistency test, which examines “the economic justification for the State’s claim upon the value taxed, to discover whether a State’s tax reaches beyond that portion of value that is fairly attributable to economic activity within the taxing State.” Jefferson Lines, 514 U.S. at 185. It is well-established that “domicile in itself establishes a basis for taxation” because the “[e]njoyment of the privileges of residence within the state, and the attendant right to invoke the protection of its laws, are inseparable from the responsibility for sharing the costs of government.” Lawrence, 286 U.S. at 279. Indeed, “[a] tax measured by the net income of residents is an equitable method of distributing the burdens of government,” which include public education and emergency services, “among those who are privileged to enjoy its benefits.” People of State of N.Y. ex rel. Cohn v. Graves, 300 U.S. 308, 313, 57 S. Ct. 466, 81 L. Ed. 666 (1937). Consequently, we agree with the lower court that “Philadelphia’s provision of municipal benefits and services to its residents provides sufficient economic justification for the imposition of its Wage Tax.” Zilka, 2022 Pa. Commw. Unpub. LEXIS 12 at *10-11 (citation omitted). “Philadelphia avoided taxing more than its fair share of [Appellant’s] wages by providing a tax credit for 100% of the Wilmington Tax.”

We conclude that the City did not violate the dormant Commerce Clause by imposing upon Appellant the Philadelphia Tax, crediting her for the similar local tax she paid to Wilmington, but declining to afford her an additional credit for the state taxes she paid to Delaware, as the tax scheme is both internally and externally consistent and is not discriminatory against interstate commerce.

We affirm the Commonwealth Court’s decision concluding that the tax scheme is constitutional.