Blue states sue federal government over new SALT deduction cap

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Four states sued the IRS and Treasury Department on July 17, 2018, alleging a recently-enacted tax reform measure included in the Tax Cuts and Jobs Act is unconstitutional. New York, New Jersey, Connecticut and Maryland brought the challenge over the new $10,000 cap on federal income tax deductions individuals and married taxpayers may take for state and local taxes: The SALT cap. Taxpayers have historically enjoyed unlimited federal deductions for state and local taxes. 

The SALT cap garnered considerable attention during the public debate surrounding the enactment of the TCJA. Democrat-leaning states with high income tax rates opposed the cap because their residents bore the disproportionate brunt of the change. Whether and to what extent residents in these states pay more tax taking into account all federal tax changes in the TCJA package, however, has been the subject to some debate.  

The coalition of states led by New York filed the case in the U.S. District Court for the Southern District of New York.  According to the complaint, the federal cap will disproportionately depress home values in their states, harm consumer spending and economic growth, and curtail the states’ ability to raise tax revenue for essential public services including public education, medical care, and police protection. These effects, the states say, violate fundamental principles of state sovereignty under the Tenth Amendment. The complaint further alleges the cap violates the Sixteenth Amendment because the constitutional authority it grants to Congress to levy an income tax inherently requires the SALT deduction to avoid interfering with state sovereignty.  

The case is the latest effort from these states to address the federal SALT deduction cap under the TCJA.  Earlier this year, New York, New Jersey and Connecticut passed laws designed to allow taxpayers to make federally deductible “charitable contributions” to local governments in exchange for credits against state and local taxes. These laws, as we have reported, are subject to challenge on the basis that contributions in exchange for tax credits do not carry with them the donative intent characteristic of charitable endeavors or gifts.  

As for the case filed on Tuesday, the states face an uphill battle. While states are separate sovereigns, so too is the federal government with its own attendant taxing power and considerable discretion to levy and collect taxes. We expect to hear more from the federal government as the case progresses. 

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