Can Utah residents claim tax credits for out-of-state franchise taxes? MacFarlane v. Utah State Tax Commission Explained

The Utah Supreme Court’s decision in MacFarlane v. Utah State Tax Commission clarifies an important aspect of Utah’s tax credit statute for Utah residents doing business in multiple states. The case involved shareholders of S corporations who sought credits against their Utah income taxes for corporate franchise taxes paid by their corporations to Texas and California.

Background and Facts

Four groups of Utah taxpayers were shareholders in S corporations that conducted business in other states. Because S corporations are pass-through entities, the shareholders were ultimately responsible for taxes imposed on their corporations. Texas and California imposed corporate franchise taxes on these S corporations, which the shareholders paid. The taxpayers then sought credits against their Utah individual income taxes under Utah Code section 59-10-106, but the Utah State Tax Commission denied the credits.

Key Legal Issues

The central issue was whether Utah Code section 59-10-106 allows credits for taxes “on income” when those taxes are labeled as franchise taxes rather than income taxes. The Tax Commission argued that there is a legal distinction between franchise taxes and taxes “on income,” even when both are measured by income.

Court’s Analysis and Holding

The Court rejected the Tax Commission’s narrow interpretation, holding that the term “on income” includes taxes measured by or calculated according to income, regardless of their label. The Court emphasized the plain language of the statute and noted that the Legislature could have used the restrictive term “income tax” if it intended a narrower scope. The Court also relied on the statute’s purpose of preventing double taxation, noting that a label-based approach would frustrate this legislative intent.

Practice Implications

This decision provides important guidance for taxpayers with multi-state business operations. When evaluating eligibility for tax credits under Utah Code section 59-10-106, practitioners should focus on the economic substance of the tax rather than its formal designation. The decision also reinforces that while tax credit statutes may be strictly construed, such construction cannot defeat clear legislative intent or the statute’s underlying purpose.