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Chamberlain and Edelman: double taxation, the dormant commerce clause and a few planning considerations

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Luca Melchionna

Melchionna, New York



In the 2015 case Comptroller of Treasury of Md. v Wynne, 575 U. S. 542 (2015)('Wynne') the United States Supreme Court affirmed that a state’s tax scheme cannot ‘tax a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the state’, even when the taxpayer earns income in one state and resides in another.

In a five-to-four decision, the Supreme Court’s opinion stated that Maryland’s failure to provide credit towards its county income tax is ‘inherently discriminatory’ and a ‘tariff’ on individuals generating income elsewhere in the US. On these grounds, the Supreme Court concluded that Maryland’s tax scheme was not internally consistent and therefore violated the dormant commerce clause of the US Constitution.

On 1 June 2017, in Chamberlain v N.Y. State Dep't of Taxation & Fin., (2018 N.Y. Slip Op. 68045)('Chamberlain') the New York Appellate Division, Third Department, held that New York state (NYS)’s tax regulations do not violate the precedent established by Wynne even though, in some cases, these tax rules result in subjecting certain income to taxation by more than one state.

Although NYS provides tax credit for income taxes paid to other states, political subdivisions of the US, or provinces of Canada in certain instances, this credit is only offered for taxes paid on ‘income derived from sources within’ those jurisdictions (20 CRR-NY 120.4). Credit is not given for taxes ‘imposed by another jurisdiction upon income from intangibles’ (20 CRR-NY 120.4(d)).

On 26 June 2018, in Samuel Edelman et al, v NYS Department of Taxation and Finance, et al, (2019 N.Y. Slip Op. 66249)('Edelman') the Supreme Court, Appellate Division, First Department, New York decided a very similar issue in favour of the NYS Department of Taxation.

Chamberlain and Edelman: facts and arguments of both sides

Between 2009 and 2011, petitioners Richard Chamberlain and Martha Crum resided primarily in Connecticut but worked and owned a second residence in New York City, NYS. The couple filed a joint tax return in both Connecticut and New York but paid taxes exclusively in their domiciliary state, Connecticut. Because they maintained a permanent place of abode in NYS and spent more than 183 days per year in NYS, they also met the statutory definition of a New York resident for each of the relevant tax years.

The NYS Department of Taxation & Finance assessed a tax deficiency of over US$2.7m for the Chamberlains due to income resulting from the 2007 sale of Mr. Chamberlain’s company and other income from intangible assets. The NYS Department did not provide tax credit for payments the taxpayers had already made to Connecticut because the income did not result from any business or property situated in another jurisdiction.

‘New York taxes the intangible income of both its domiciliary and non-domiciliary residents, and it does not offer any credit for taxes paid to another State on that same income—even if the other State is the individual’s State of domicile’ (Chamberlain, at 7).

In the 2017 Appellate Division, Third Department holding, the NYS Department of Taxation relied on Matter of Tamagni v Tax Appeals Tribunal of State, (91 N.Y.2d 530, 695 N.E.2d 1125, 673 N.Y.S.2d 44, 1998 N.Y. LEXIS 1071) ('Tamagni') where the NYS Court of Appeals in 1998 held that: ‘the statute [20 CRR-NY 120.4] does not substantially affect interstate commerce and, therefore, the protections of the dormant Commerce Clause are not applicable. Even assuming arguendo that the Commerce Clause implicated, the tax does not violate the dormant Commerce Clause’ (Tamagni at 530).

The Chamberlains, on the other hand, argued that Wynne abrogated Tamagni. As a matter of fact, Tamagni relied on the ‘internal consistency test’ (used to evaluate the constitutionality of a tax on interstate commerce) expressed in Container Corp. of America v. Franchise Tax Bd. (463 US 159 (1983)): a tax ‘must be such that, if applied by every jurisdiction, it would result in no more than all of the unitary business’ income being taxed’ (Container at 169). ‘[T]he first step in the dormant Commerce Clause inquiry’ is ‘to identify the interstate market that is being subjected to discriminatory or unduly burdensome taxation’ (Tamagni at 534).

In the absence of such a discernable market, ‘it does not violate the dormant Commerce Clause,’ nor is the ‘interstate Commerce Clause… implicated by the New York income tax’ (Tamagni at 533).

Finally, having established state authority to tax intangible income and the irrelevance of the commerce clause to their case, the court appealed to a long history of congressional and judicial support for ‘the right of States to tax economic activities within their borders’ (Tamagni at 535). Ultimately, the 2017 Appellate Division, Third Department, rejected the arguments of the Chamberlains.

Similarly, in Edelman, the NYS Appellate Division, First Department ruled that Tamagni can be distinguished from Wynne because:

‘First, [Wynne] did not involve individuals who faced double taxation on intangible investment income by virtue of being domiciliaries of one state and statutory residents of another. Second, the income subject to tax in Wynne was not intangible investment income, but business income, traceable to an out-of-state source’ (Edelman at 575).

Evoking the precedent established by the Tamagni court, the court noted that where ‘the statute at issue does not affect interstate commerce, there is no need for a test determining whether the statute unduly burdens interstate commerce’ (Edelman at 576).

Writ of Certiorari: petitions denied

On 24 June 24 2019, the Chamberlains (and later the Edelmans) filed a petition for a Writ of Certiorari with the US Supreme Court, maintaining that the NYS Appellate Division’s decision ‘is plainly inconsistent with [the Supreme Court’s] decision in Wynne’ (at 2). The Chamberlains maintain that the Appellate Division violated the constitutional dormant commerce clause that prohibits a state from ‘tax[ing] a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State’. Armco Inc v Hardesty, 467 US 638, 642 (1984).

Wynne clarified the ‘internal consistency test’ used to determine whether there is any disadvantage or a discrimination in a cross-border transaction. The Appellate Division violated Wynne – the Chamberlain argument goes – because there was no justification to tax intangible income twice.

On 7 October 2019 the US Supreme Court denied both petitions, meaning that Tamagni and Wynne will need to coexist. The denial of both parties’ petitions makes NYS’s tax scheme effective and – at least for now – constitutional.

The basic idea behind Chamberlain and Edelman is that if a taxpayer is both a statutory resident of one state and a domiciliary resident of another state, income generated from intangible assets (eg, dividends, interest, royalties) may be taxed by both states without the application of any mitigating tools like tax credit. For NYS, simply maintaining a permanent place of abode and spending over 183 days per year there is enough to trigger the applicable part of the NYS tax code (NY Tax Law § 605(b)(1) (B)).

Corporate and tax planning considerations

The residency rule is not a novelty: 40 US states have some form of statutory residency regulations and 18 of them (NY included) use the 183-day rule. In NYS, the application of 20 CRR-NY 120.4 is triggered when a taxpayer earns income from intangibles and meets the state statutory residency requirements.

The Tamagni Court recognised the legal basis for this tax scheme as the ‘long-recognized doctrine of mobilia sequuntur personam ([‘(m)ovables follow the . . . person’])’ (Tamagni at 14). Therefore, when a taxpayer disposes of a business (in the form of stock) the source of the income from that sale – at the time of disposal – happens to be in NYS because the presumption is that intangible income follows its owner who is a statutory resident of New York.

Finally, with reference to income generated from sale of a business, one consideration must be made to the value of the business: interstate commerce is involved if at the time of disposal income is the result of value created by business activity conducted across state lines. In the case of the Chamberlains’ business, tax credit should not simply have applied to offset double taxation but to provide relief to the taxpayers for benefit that the state obtained from interstate activity conducted over the years leading up to its sale. Certainly, the value of the business’ ownership interest and the taxes it paid had increased due to various components derived from interstate trade, like business reputation, goodwill and intellectual property.

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