The Buzz

Kansas City inviting federal lawsuit over collection of the earnings tax, potentially clouding April election

In a memo released Tuesday, Kansas City’s legal department argues the city’s one percent earnings tax is unaffected by a 2015 Supreme Court case that prohibits double-taxation of income across state lines. The documents is part of a furious push-back by city officials angry at state Sen. Kurt Schaefer’s proposal to eliminate the levy at the end of 2017.

The legal argument, offered by the city attorney’s office, insists the Court’s decision will have no impact on the Kansas City E-tax, either for people who live in Kansas City, Mo. or work inside its limits.

The earnings tax is clearly constitutional. But the logic and language of the city’s argument may misread the Supreme Court case, virtually inviting a federal court challenge testing the breadth of the Court’s ruling earlier this year. It may, at minimum, cloud the campaign for renewal of the tax next year.

Here’s why.

The Supreme Court case came from Maryland. Like most states, Maryland collects income taxes from residents and people who work within its borders. Similar collection strategies exist in other areas: if you live in Kansas but work in Missouri, or vice versa, you’re familiar with this fact. You pay income taxes to both states.

But because you can’t be taxed on the same income twice at the state level, Missouri and Kansas offer credits to residents for taxes paid to other states. If I live in Kansas and owe a $500 income tax, but paid Missouri $500, I file for the credit and reduce my Kansas liability to zero. The same policy works in the other direction.

Maryland offered the same tax credit for taxes paid in, for example, Virginia. But it also collected an income tax for use at the county level, and by the City of Baltimore. It did not offer a credit for taxes paid in other states against the liability for those local taxes.

The Supreme Court decided that levy for local governments was illegal. “The effect of this scheme is that some of the income earned by Maryland residents outside the State is taxed twice,” it ruled.

The city’s analysis — exempting itself from that finding — relies on two arguments. The first claims the one percent tax is levied equally against everyone who lives or works in the city:

“The State (municipality) cannot tax the transaction (earning of income) more heavily when it crosses state lines than when it occurs entirely within the state,” the document says. “If the earnings tax were altered so that persons who earned their income from outside the state had to pay a two percent tax, it would be taxed more heavily and violate interstate commerce, but it does not.”

That statement is true but likely irrelevant. The Court said the tax scheme was illegal, not because the rates were different for residents and non-residents but because it taxed the same income twice — effectively making the taxes different, depending on where the income was earned, even though the rates might be the same for everyone.

That, the Court said, is an unconstitutional tariff.

Then the city’s legal department says this:

“The second prohibition is that interstate commerce cannot be subjected to the burden of multiple taxation. If Kansas City and St. Louis residents, who earned income outside the state, were paying a local earnings tax to where they earned their income and also to Kansas City and St. Louis, due to the fact that they are residents, this would result in the burden of multiple taxation at the municipal level, and discriminate against interstate commerce. However, Kansas City and St. Louis allow a credit offset to their earnings tax for any earnings tax paid elsewhere. This results in the earnings tax only being paid once, and eliminates any multiple taxation. So, the earnings tax does not run afoul of this prohibition either.”

But the city offers no explanation as to why “multiple taxation at the municipal level” is illegal but multiple taxation at the state-municipal level is fine. The city seems to be arguing that the earnings tax isn’t a state tax — that’s why it offers a credit for earnings taxes residents pay to the city of St. Louis, but not to the state of Kansas.

There are several reasons this thinking might be flawed.

Remember, the Supreme Court case involved Maryland taxes collected for its counties and Baltimore, not for state government. And the earnings tax in Kansas City and St. Louis is authorized by state law, suggesting some state role for the levy.

Moreover, if the city’s logic were sound, it would apply in both directions: Kansas and Illinois would not need to offer credits for earnings taxes in Kansas City or St. Louis. Yet both states offer credits for state and local income taxes — precisely to avoid the double taxation problem.

Here’s what Kansas said in August:

“On May 18, 2015, the United States Supreme Court issued its ruling in the case of Maryland v. Wynne (Docket No. 13-485). The Court’s decision indicates that, under state law similar to that in Kansas, an income tax credit for taxes paid to another state should recognize both income or earnings taxes imposed by the other state, and income or earnings taxes imposed by local units of government of the other state.

Back in May I asked a national expert if local earnings taxes are legally different from state income taxes.

“You need to analyze the local tax as if it were a state tax, just as the court did,” said Walter Hellerstein, a professor at the University of Georgia and a nationally recognized expert in state and local tax law. “For federal constitutional purposes, the distinction between state and local taxes has no meaning. They’re all exercises of state power insofar as the Constitution is concerned.”

Hellerstein’s view was not reflected in the city’s earnings tax document Tuesday.

The city’s belief that it is exempt from offering its residents a credit for income taxes they pay to other states rests on an assertion — that a local income tax is fundamentally different from a state income tax. The Wynne court suggests something else.

Someone who lives in Kansas City, but works in Kansas, may be tempted to test the city’s assertion in court.