Judge to hear arguments in SALT lawsuit as Trump administration prepares final regulation

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WASHINGTON — A lawsuit by New York and other states challenging challenging a 2017 tax provision that capped the federal deduction for state and local taxes at $10,000 is set to be argued in federal court next month, while the Trump administration continues to delay the release of final regulations to enforce that cap.

The Treasury and Internal Revenue Service sent the proposed final regulation to the White House Office of Management and Budget over six weeks ago, and it had been widely expected to be publicly promulgated before the April 15 end of the tax filing season.

In the meantime, the regulation proposed last August stands as an interim measure to prevent states from using workarounds such as charitable foundations as loopholes to avoid the cap. It also limits the use of state tax credits, which some public education groups and think tanks say will end abusive tax shelters.

Six of the 18 states with tax credits for donations to private school scholarships also allow taxpayers to deduct the same donation as a federal charity deduction.

That previously led tax advisers in some states to advertise opportunities for high income households to use a combination of state tax credits and the federal charitable deduction to gain a combined reduction in taxes that’s larger than the dollar value of the donation.

The interim regulation also allows taxpayers to use the federal charity deduction only for the amount of a donation that’s not used for a state tax credit.

Meanwhile, U.S. District Court Judge J. Paul Oetken has set June 18 for oral arguments in the lawsuit filed last July by New York, New Jersey, Connecticut and Maryland arguing that the SALT cap has encroached on their sovereign authority to determine their own taxation and fiscal policies.

The SALT cap affected an estimated 10.88 million taxpayers in 2018 with them collectively losing $323.13 billion in deductions, according to a February report by the Treasury Inspector General for Tax Administration.

In a court filing last month, the four states said the 2017 tax provision “disregards fundamental constitutional restraints that prevent the federal government from interfering with the states’ sovereign authority to make their own choices about whether and how much to invest in their own residents, businesses.”

The four states also said their residents will pay $121 billion in additional federal income taxes between 2018 and 2025 because of the cap on the SALT deduction.

The New York State Division of the Budget said the SALT deduction cap will depress real estate values and home sales, and that the resulting decline in household wealth could result in the loss of between 12,500 and 31,300 jobs and depress New York’s economy generally. That analysis also said home sales in Westchester County, Long Island and Manhattan are down, and growth in home sale prices has either slowed or declined in several counties.

"Congress enacted the SALT deduction cap with an illegitimate motive—to punish States that have elected to raise revenue through relatively high taxes and to make substantial public investments," the states said in their court filing.

The Trump administration wants the lawsuit dismissed.

"Before the enactment of the 2017 Tax Act, many taxpayers’ ability to take deductions for state and local taxes paid was significantly limited by a number of provisions, including the AMT and the Pease limitation," the administration's filing said.

A coalition that includes the U.S. Conference of Mayors, the National League of Cities, the National Association of Counties, the Government Finance Officers Association and the International City/County Management Association sent the IRS a letter in October saying “the proposed regulations would hinder the ability of governmental entities to effectively, efficiently and economically serve their communities.”

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State and local finance SALT deduction Compliance Enforcement Treasury Department TIGTA IRS Washington DC
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