MARYLAND COURT CASE UPDATE. By: BRIAN L. OLINER, ESQ. Presented By: JOHN BARRY, ESQ.

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1 MARYLAND COURT CASE UPDATE By: BRIAN L. OLINER, ESQ. Presented By: JOHN BARRY, ESQ. ASSISTANT ATTORNEY GENERALS COUNSEL TO THE COMPTROLLER OF MARYLAND A. Brian and Karen Wynne v. Comptroller of the Treasury Assessment affirmed by Maryland Tax Court. On appeal by Petitioners to the Circuit Court for Howard County reversed. Comptroller noted appeal to the Maryland Court of Special Appeals. Taxpayers, Maryland residents, appealed to the Maryland Tax Court from the Comptroller s Notice of Final Determination affirming an assessment against them for income tax owed for the tax year In their appeal, the taxpayers raised two issues. First, they contested the applicability of Tax Gen. Art (c)(1) for calculating a credit for taxes paid by the taxpayers or an s-corporation, in which they owned shares to other states on the income earned by them as 2.4% shareholders of the Maryland S- corporation. The second issue, raised in an amended Petition of Appeal, argued that Tax Gen. Art., violates the Commerce Clause of the United States Constitution by not allowing the credit against local income taxes. The S-corporation operated in 39 states, some of which recognized its status as an S-corporation and some which did not. Consequently, in some states the taxpayer paid a tax on his income, whereas in other states the corporation paid a tax on its income apportioned to that state. Recognizing this situation, Tax Gen. Art., (c)(2) still allows a taxpayer to take a credit for taxes paid even though the tax was actually paid by the S-corporation in which he is a shareholder. The taxpayers Commerce Clause argument asserts that the failure to allow a credit against the local (county) tax fails the fair apportionment prong (specifically the internal consistency test ) of the Complete Auto Transit test. Maryland Tax Court affirmed assessment on December 10, The taxpayers appealed. On appeal they are only pursuing the Commerce Clause issue. On June 29, 2011, the Circuit Court for Howard County issued its decision, reversing the decision of the Maryland Tax Court. The Circuit Court ruled that Tax Gen. Art., (a) was unconstitutional, violating the dormant commerce clause of the U.S. Constitution. On July 21, 2011, the Comptroller noted an appeal to the Maryland Court of Special Appeals.

2 B. Timothy Frey, et al. v. Comproller of the Treasury, Md, WL , September 29, 2011, Maryland Court of Appeals. Assessment of State non-resident tax (SNRT) affirmed by Maryland Tax Court. On appeal to the Court of Appeals, assessment affirmed, holding that the SNRT does not violate the Commerce Clause, the Equal Protection Clause, the Privileges and Immunities Clause of the United States Constitution, does not violate Article 24 of the Maryland Declaration of Rights. Further holding that the Maryland Tax Court does have the power to review and abate interest assessments. In Frey, et al., the Court of Appeals sustained the constitutionality of Tax-General Article The statute imposes a special state tax on non-residents equal to the lowest rate of tax set by any Maryland subdivision. Nonresidents are generally exempt from the local tax. The taxpayers (all out of state residents) argued that the tax was discriminatory and unconstitutional because it was not imposed on residents, but only on nonresidents. The Court of Appeals affirmed the Tax Court decision and upheld the tax, reasoning that the constitution does not look to labels such as state tax or county tax, but instead finds discrimination only if the actual dollars paid by a nonresident are greater than the amount paid by a resident. A second issue in the case is whether the Tax Court has discretionary authority to reduce an assessment of interest. The Comptroller argued (and the Tax Court agreed) that no such authority exists. The Court of Appeals held that the Tax Court does have authority to reduce the amount of interest, and remanded to the Tax Court for specific findings on this issue. A dissenting opinion was filed in this matter. The dissent opines that the county tax and, thus, the SNRT are separate and distinct taxes from the general State income tax. With that conclusion, then the SNRT is not a valid compensatory tax and does not survive Commerce Clause scrutiny. C. Nordstrom, Inc v. Comptroller of the Treasury; NIHC, Inc. v. Comptroller of the Treasury; N2HC, Inc. v. Comptroller of the Treasury Assessment affirmed by Maryland Tax Court. On appeal to the Circuit Court for Baltimore County the matter was remanded. On remand, the assessment was again affirmed. Appealed again to the Circuit Court for Baltimore County. Decision pending. The Tax Court affirmed the assessments against Nordstrom s two subsidiaries, NIHC and N2HC. The alternative assessment against Nordstrom was rescinded. Nordstrom and NIHC noted appeals to the Circuit Court for Baltimore County. The Comptroller filed a cross-petition in the Nordstrom case. N2HC did not appeal. In August, 2009, the Circuit Court issued an order and memorandum opinion remanding the cases back to the Tax Court. The Circuit Court directed the Tax Court to decide: 1) whether or not the IRC 311(b) gain of NIHC, or any part thereof, constituted Maryland taxable income; 2) if so, whether the Maryland requirement of separate entity income tax returns prohibited taxing the 311(b) deferred gain; and 3) whether Nordstrom s royalty payment deductions were ordinary and necessary business expenses.

3 The Tax Court initially affirmed the assessment against NIHC, but failed to answer the second question. On request of the Petitioner, the Tax Court revisited the matter and, on July 15, 2010, again affirmed the assessment. The Tax Court unequivocally determined that the income, characterized as 311(b) gain was Maryland taxable income: In the instant case, it is clear to this Court that but for the activities of Nordstrom and its use of the trademarks in Maryland, the gain of NIHC would not have been recognized One cannot separate the value of the trademarks, the licensing of the trademarks and the gain recognized by NIHC from the Nordstrom activity in Maryland. On the second question, the Court found that there is no prohibition arising from the separate reporting requirements when the income is attributed to the activity of the parent and its use of the marks in Maryland. NIHC again noted an appeal to the Circuit Court. The matter was argued in the Circuit Court in May A decision is pending. D. State of Maryland (Appellee) v. Denise Ciotti (Appellant), U.S. Court of Appeals for the 4 th Circuit, Case No F.3d 276 (4 th Cir. 2011). This matter concerns whether or not a State income tax debt is discharged if the taxpayer fails to file a report with the State after the IRS has made a final determination adjusting the federal return. In 1996 Mrs. Ciotti filed her Maryland income tax returns. In 1998 the IRS issued a letter of determination adjusting the returns. The total adjustment for all years increased taxable income by more than $2.6 million. Mrs. Ciotti never reported the adjustments as required by Md. Ann. Code, Tax Gen (b). Subsequently, the Comptroller adjusted the returns, resulting in an income tax liability, including interest and penalty, in excess of $500,000. In February 2006, the State filed a tax lien. On April 9, 2007, Mrs. Ciotti filed Chapter 7 bankruptcy. She received her discharge on August 22, On February 27, 2008, the State attached Mrs. Ciotti s bank account. Though the funds in the account were ultimately applied to different tax years, Mrs. Ciotti filed an adversary action in the bankruptcy court asserting that the State income tax debt had been discharged. At issue is the application of 11 U.S.C. 523(a)(1) which excepts from discharge any debt for a tax with respect to which a return, or equivalent report or notice, if required was not filed or given. The highlighted language was added to the statute in Prior to the addition of this language it was clear, based on case law, that failure to file the report required by would not prevent discharge. The Bankruptcy Court agreed with Mrs. Ciotti and concluded that, even with the amendments, a return was still required by the applicable state statute. The U.S. District Court for Maryland disagreed and reversed. It held that based on the prior case law and the intent of Congress as gleaned from the reports accompanying the changes to the

4 Bankruptcy Code in 2005, the added language did expand the exception to include a report such as is required by The taxpayer appealed the matter to the U.S. Court of Appeals for the Fourth Circuit. On March 8, 2011, the appellate court issued a published opinion affirming the decision of the District Court. The Court concluded that the report required by Tax Gen. Art., is indeed the type of report to which Congress intended 11 U.S.C. 523(a)(1)(B) to apply. E. Gore Enterprise Holdings v. Comptroller; Future Value, Inc. v. Comptroller On November 9, 2010, the Tax Court affirmed the Comptroller s assessment against two Delaware holding company ( DHC ) subsidiaries of W.L. Gore & Associates. One subsidiary earned patent royalties based on a percentage of sales made by the unitary parent; the second earned interest income from loans made out of accumulated royalty profits that were transferred to it from the DHC that owned the patents. The Tax Court held that the companies were engaged in a unitary business; that they had no real economic substance as separate business entities; that they depended on the operating parent company for their assets and income; and that there were direct connections between Maryland activity and the royalty and interest income. On August 26, 2011, the Circuit Court for Cecil County (Judge Daniels, Retired, sitting by designation) reversed the Tax Court in the case of the patent royalty subsidiary, Gore Enterprise Holdings. He ruled from the bench that the company was not taxable by Maryland because patent royalties were different from trademark royalties under the Commerce Clause, and the conduct of a unitary business by the holding company and its operating parent does not create nexus or connection between Maryland and the DHC, because under the Commerce Clause nexus must exist independently of the unitary business. On September 30, 2011, the circuit court reversed the Tax Court decision on the interest subsidiary (Future Value, Inc.) as well. The Comptroller is expected to appeal. F. Wanda King v. Comptroller Refund denial affirmed by Maryland Tax Court. On February 15, 2011, the Court of Special Appeals reversed the unfavorable decision of the Circuit Court for Calvert County and remanded the case with a direction that the Circuit Court affirm the decision of the Tax Court denying income tax refunds to the taxpayer. Taxpayer appealed to the Court of Appeals.

5 The taxpayer, Wanda T. King, sought a refund following receipt of a final adjustment report of the Internal Revenue Service dated January 3, King was due a substantial federal refund based on the final adjustment report. She contended that based on the downward adjustment of her federal adjusted gross income by the IRS, as reflected in the final adjustment report, her corresponding Maryland adjusted gross income would have generated refunds in 1999 and Unfortunately for King, she waited almost 13 months after the date of the IRS s final adjustment report to file her Maryland refund claims for 1999 and Because King s refund claims were filed more than one year after the date of the IRS final adjustment report, the Comptroller determined that King s refund claims were untimely under TG (c)(2). The Tax Court agreed with the Comptroller in a decision dated August 28, On judicial review, the Calvert County Circuit Court reversed the Tax Court. As indicated above, the Court of Special Appeals reversed the Circuit Court and ordered that the favorable decision of the Tax Court be reinstated. Arguments are set for November 2011 in the Court of Appeals.