Utah: Equitable Adjustment Prov. Do Not Apply to Avoid Double Taxation of Foreign Bus. Income

The Utah Supreme Court recently reviewed a constitutional challenge to Utah’s individual income tax structure, as it applied to foreign and interstate business income of S corporation shareholders. The taxpayers, residents of Utah, were shareholders in an S Corporation that generated about 98 percent of its income from activities outside of Utah. Utah’s individual income tax, as is typical with state income taxes on individuals, taxes residents on all income, whether generated within Utah, another state, or a foreign country. Also, as is typical with state income taxes on individuals, Utah provides residents with a credit against their Utah tax for income taxes paid to other states. However, residents do not receive credit for taxes paid to foreign jurisdictions. In addition, Utah law allows qualified taxpayers to claim “equitable adjustments” to their Utah adjusted gross income if a lack of an adjustment would result in a “double tax detriment.” The taxpayers at issue claimed an equitable adjustment by removing their foreign business income from their Utah taxable income. The Utah Tax Commission disagreed with the adjustment. The matter eventually went to district court where the taxpayers also argued that Utah’s individual income tax was not fairly apportioned because Utah taxed residents on all income wherever earned. The trial court held (1) that apportionment of the taxpayer’s income was not required and (2) that the taxpayer’s were entitled to an equitable adjustment for the foreign business income under the Foreign Commerce Clause. Both parties appealed.

On appeal, the Utah Supreme Court first analyzed and applied the U.S. Supreme Court decision, Comptroller of the Treasury of Maryland v. Wynne, to address the taxpayer’s claims that they should be entitled to apportion their income. The Wynne court, the Utah court concluded, had struck down Maryland's tax system solely on the basis of internal consistency. Further, the High Court did not apply the Complete Auto test and it “strongly implied” that tax systems that fail external consistency would nonetheless pass constitutional muster. On this basis, the Utah Supreme Court, applying the internal consistency test alone, held that Utah’s tax scheme was internally consistent because if every state adopted the same tax system there would be no discrimination against interstate commerce. However, the court disagreed with the lower court’s holding that Utah’s failure to allow the taxpayers a credit for taxes paid to foreign jurisdictions discriminated against foreign commerce. In reaching this conclusion, the court declined to extend the Dormant Foreign Commerce Clause to individuals because the U.S. Supreme Court has never “struck down a state tax on the foreign income of an individual or an S corporation” and the extension advocated by the taxpayers would “open a can of worms.” On the issue of whether the taxpayers were entitled to an equitable adjustment of their foreign income, the court determined that the taxpayers’ situation did not meet the plain meaning of the statutory requirement. Utah law allows qualified taxpayers to claim “equitable adjustments” to their Utah adjusted gross income if a lack of an adjustment would result in a “double tax detriment under this part.” The court noted that this language applies specifically to situations where the Utah tax code itself imposed the double taxation. The court found that Utah taxed the foreign income once and that the “second tax detriment they suffered was at the hands of a foreign sovereign.” Please contact Michael Larkin at (801) 237-1335 with questions on Steiner v. Utah State Tax Commission.