Can Utah taxpayers claim credits for out-of-state franchise taxes measured by income? MacFarlane v. Utah State Tax Commission Explained

The Utah Supreme Court’s decision in MacFarlane v. Utah State Tax Commission provides important guidance for taxpayers seeking credits for out-of-state taxes paid by their S corporations. The case clarifies that Utah Code section 59-10-106 permits credits for franchise taxes measured by income, not just taxes formally labeled as “income taxes.”

Background and Facts

Four sets of Utah resident taxpayers owned shares in S corporations doing business in Texas and California. These states imposed corporate franchise taxes on the S corporations, measured by income or earned surplus. The taxpayers sought credits against their Utah individual income taxes for their pro rata shares of these franchise taxes under Utah Code section 59-10-106. The Utah State Tax Commission denied the credits, distinguishing between taxes “on income” and franchise taxes “measured by income.”

Key Legal Issues

The central issue was statutory interpretation of the phrase “on income” in Utah Code section 59-10-106. The Tax Commission argued for a narrow construction that excluded franchise taxes, even when measured by income. The taxpayers contended the statute’s plain language supported a broader interpretation encompassing any tax measured by income.

Court’s Analysis and Holding

The court applied the correctness standard for statutory interpretation questions. Focusing on the plain language of section 59-10-106, the court noted the Legislature used the broad term “on income” rather than the more restrictive term of art “income tax.” The court emphasized that the substance and effect of a tax, not its label, determines whether it qualifies for credit. Since the franchise taxes were measured by income, they effectively taxed the same income stream subject to Utah taxation, creating the double taxation the credit statute was designed to prevent.

Practice Implications

This decision establishes that Utah’s tax credit statute should be interpreted broadly to achieve its anti-double-taxation purpose. Practitioners should focus on whether an out-of-state tax is measured by income rather than how the imposing jurisdiction labels it. The decision also demonstrates that while strict construction principles apply to tax credits, they cannot defeat clear legislative intent reflected in the statute’s plain language.