By Patrick K. Skeehan, JD
Pennsylvania Commonwealth Court ruled in January that a Philadelphia resident taxpayer who worked in Wilmington, Del., 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’s policy of granting a credit for local tax paid to other localities while disallowing a credit for state income tax paid was justified on the grounds that state and local income taxes are levied separately. However, the court’s analysis raises several important questions.
During the tax years at issue, Diane Zilka was a Philadelphia resident who commuted to Wilmington, where her employer was based. Philadelphia residents are subject to city wage tax on all of their compensation, but may claim a credit for similar taxes paid to other jurisdictions. In 2017, Zilka filed a petition with the Philadelphia Department of Revenue to refund a portion of her city wage tax liability paid from 2013-2016. During these years, Zilka’s employer withheld four state and local taxes: city wage tax, Wilmington earned income tax (Wilmington EIT), Pennsylvania personal income tax (Pennsylvania PIT), and Delaware personal income tax (Delaware PIT).
At the state level, Zilka claimed a credit for the portion of Delaware PIT (imposed at a 5% rate) that offset her entire Pennsylvania PIT liability (imposed at a 3.07% rate). The taxpayer also paid city wage tax at the 3.92% resident rate and claimed a credit for Wilmington EIT paid (imposed at a 1.25% rate).2 Zilka then claimed a credit for the remaining 1.93% of Delaware PIT paid to offset her remaining city wage tax liability. The Philadelphia Department of Revenue allowed a credit for the Wilmington EIT paid, thereby reducing Zilka’s city wage tax effective rate to 2.67% (3.92% minus 1.25%). However, it disallowed as a credit the remaining portion of the PIT paid to Delaware. Zilka appealed to the Philadelphia Tax Review Board, and subsequently to the Philadelphia County Court of Common Pleas. Both upheld the Philadelphia Department of Revenue’s decision to disallow the remaining Delaware PIT paid. The case was then appealed to Pennsylvania Commonwealth Court.
On appeal, Zilka argued that Philadelphia’s refusal to allow the remaining Delaware PIT credit to offset her city wage tax liability was a violation the commerce clause of the U.S. Constitution. Specifically, Zilka alleged that Philadelphia’s policy was not fairly apportioned because it resulted in the double taxation of her income. Zilka also claimed that the denial of a credit for PIT paid to Delaware was discriminatory, in that it resulted in her paying more tax than taxpayers who did not cross state lines to go to work.
To determine whether the policy violated the Commerce Clause, the court applied the four-part test from a well-known U.S. Supreme Court decision, Complete Auto Transit Inc. v. Brady,3 focusing on the fair apportionment and discrimination prongs of the test. First, the court determined that Zilka’s income was not being doubly taxed because she was not paying more than one state or local tax. Acknowledging that Zilka pays more city wage tax than similar taxpayers working in-state, the court explained that Zilka “chose to work in Delaware, which charges a higher income tax than Pennsylvania.” The court concluded that there was no double taxation because Zilka paid city wage tax at the same rate as in-state taxpayers.
Moving to Zilka’s fair apportionment arguments, the court examined whether Philadelphia’s crediting policy satisfied two separate tests: the internal consistency and external consistency tests. The internal consistency test considers the structure of a state or local tax system to determine whether there are occurrences where taxpayers are paying more tax in more than one state or local jurisdiction in a way that would discriminate against interstate commerce.4 The court determined that the policy met the internal consistency test because, 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 found that Zilka 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 jurisdiction.5 In the court’s view, Philadelphia fairly apportioned city wage tax to the taxpayer by providing a credit for tax paid to Wilmington, and therefore was not taxing all the taxpayer’s income. Further, the court noted that Philadelphia’s provision of municipal benefits and services to residents provides “sufficient economic justification” for taxing income earned outside the city.
The court distinguished Zilka’s facts from those in Maryland Comptroller of the Currency v. Wynne, a 2015 U.S. Supreme Court decision that considered the constitutionality of Maryland’s personal income tax (Maryland PIT) structure.6 In Wynne, 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 – or “county” – portion of its PIT for taxes paid to other states. Previously, Maryland had provided a credit for income tax paid by resident taxpayers to other states against only the state portion of the taxpayer’s Maryland PIT liability.
Finding Wynne to be factually distinguishable from Zilka’s case, the court found that the decision did not require Philadelphia to permit an additional credit for 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. As such, the court determined that the policy did not violate Wynne because Philadelphia offers a credit for municipal taxes paid to local jurisdictions, such as Wilmington. Concluding that Philadelphia’s policy did not result in double taxation or an otherwise discriminatory practice, the court upheld the denial of the credit claimed for Delaware PIT paid.
The Commonwealth Court ultimately found that the factual distinctions when compared to the Wynne case were important enough for Philadelphia’s crediting policy to withstand commerce clause scrutiny. The most 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 have a certain degree of discretion over the imposition of and the rate of local income tax paid, suggesting that the distinction may not be as great as the court made it out to be.
The court, likewise, did not directly address the argument advanced in Wynne that state and local taxes should be considered together when undergoing constitutional scrutiny. Zilka argued that Philadelphia taxes should be analyzed in conjunction with Pennsylvania taxes because the city derives its taxing powers from Pennsylvania law and requires approval from the state legislature to amend its taxing regime.7 The connection between the Pennsylvania and Philadelphia tax regimes supports the argument that they should be viewed as a whole for constitutional purposes.
In February 2022, Zilka filed an appeal with the Pennsylvania Supreme Court. The ultimate outcome of the Zilka case carries 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. Therefore, Philadelphia residents working remotely for a Delaware-based employer may be subject to Delaware PIT (and maybe Wilmington EIT) if they are not required to telecommute in a post-pandemic environment.
Despite the factual differences the court drew between Wynne and Zilka, the result of both cases is that taxpayers working outside their resident state or deriving income from out-of-state sources ultimately pay more tax than their resident counterparts who do not. This raises the question of whether the Commonwealth Court sufficiently examined the constitutional issues by looking at the Philadelphia policy on its own without considering its interaction with Pennsylvania’s overall tax structure. Another looming question is whether sustaining Philadelphia’s tax system based on factual distinctions alone is sufficient to satisfy commerce clause requirements. These questions may soon be considered by the Pennsylvania Supreme Court should it decide to hear the case.
1 Zilka v. Philadelphia Tax Review Board, Nos. 1063 C.D. 2019 and 1064 C.D. 2019 (Pa. Commw. Ct. Jan. 7, 2022).
2 The parties used tax rates from the 2014 tax year for purposes of providing tax calculations in their briefs. Noting that slight income tax rate variations existed during the tax years at issue, the Commonwealth Court referred to the same 2014 tax rates in its decision, and those same rates are used for the purposes of this article.
3 Under Complete Auto, a state or local tax satisfies commerce clause requirements if the taxpayer has substantial nexus with the taxing jurisdiction; the tax is fairly apportioned; the tax does not discriminate against interstate commerce; and there is a reasonable relationship between the tax imposed and the services being provided by the taxing jurisdiction. 430 U.S. 274 (1977).
4 See Oklahoma Tax Commission v. Jefferson Lines Inc., 514 U.S. 175 (1995).
5 Jefferson Lines, 514 U.S. at 185, citing Goldberg v. Sweet, 488 U.S. 252 (1992).
6 575 U.S. 542 (2015).
7 Philadelphia’s taxing authority is governed by state-enabling legislation known as the Sterling Act and the First Class City Business Tax Reform Act. 53 Pa. Stat. Sections 15971-15973; 16181-16193.
Patrick K. Skeehan, JD, is a state and local tax senior manager with Grant Thornton LLP’s Washington National Tax Office based in Philadelphia. He can be reached at patrick.skeehan@us.gt.com.
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