Three states and a separate group of municipalities and school districts filed federal lawsuits Wednesday challenging a Trump administration regulation involving the $10,000 federal cap on state and local tax deductions for individual taxpayers.
The lawsuits seek to overturn a regulation the Internal Revenue Service and Treasury finalized last month to limit the use of state tax credits as a workaround for the $10,000 cap for the deduction often referred to as SALT.
The final IRS and Treasury regulations limit a taxpayer who claims a state tax credit to claiming only the portion of their charitable donation not covered by the state.
The regulation stymies efforts by New York and other states to create new charitable tax credits for taxpayers in lieu of payment of their homeowner property taxes or state income taxes. It also impacts tax credits in 18 states of up to 100% for private school donations, often to scholarship funds, which can be used by donors to also claim federal charity deductions.
Under the final regulation a taxpayer who receives a 70% state tax credit of $700 for a $1,000 donation would be left with a federal charitable contribution deduction of $300.
“The Trump administration's SALT policy is an economic civil war that helps red states at the expense of blue states,” New York Gov. Andrew Cuomo said in a statement announcing his state is joining with New Jersey and Connecticut to challenge the regulation.
“The final IRS rule flies in the face of a century of federal tax law that says state choices to provide tax incentives for charitable donations do not affect the federal deductibility of those gifts,” Cuomo said. “It will —for the first time and solely in the name of retribution — require taxpayers to subtract the value of state or local tax credits from their federal charitable deduction.”
That federal lawsuit was filed in the Southern District of New York, where a group of municipalities, school districts, and three suburban New York counties calling themselves the Coalition for the Charitable Contribution Deduction (3CD) filed a similar lawsuit.
The second lawsuit, Village of Scarsdale v. Internal Revenue Service et al., said the new IRS regulations have broken “with judicial precedents, published guidance binding on the IRS and the Treasury Department, IRS administrative pronouncements and settled taxpayer expectations.”
“Prior to the IRS/Treasury Department issuing their regulations, 70 active programs across 24 states already encouraged charitable contributions to various public and private programs with tax credits at the state or local level — all of which will now be denied a full charitable contribution at the federal level,” the 3CD group said in a press release.
Four states led by New York and New Jersey also filed a federal lawsuit a year ago challenging the constitutionality of the $10,000 limit. U.S. District Court Judge J. Paul Oetken in Manhattan heard oral arguments last month by the states arguing that the SALT cap has encroached on their sovereign authority to determine their own taxation and fiscal policies.
The limit on the SALT deduction already has caused an estimated 10.88 million individual taxpayers to lose $323.1 billion in tax deductions for the 2018 tax year, the Treasury Inspector General for Tax Administration reported in February.
The impact has been the greatest in high income, high tax states where many residents pay substantial property taxes and income taxes. Local governments have raised concerns that the $10,000 federal cap might make homeowners more sensitive to property tax or income tax increases, perhaps restricting the ability of local governments to raise money to finance infrastructure.
State and local government groups also have criticized the cap.
The lawsuits were filed a day after 11 Democrats in the Senate and a bipartisan group of 47 House lawmakers announced a long-shot effort to repeal the regulation using the Congressional Review Act. The group of House lawmakers were led by Democratic Reps. Rebecca "Mikie" Sherrill and Josh Gottheimer of New Jersey.
The Congressional Review Act, also known as CRA, was used successfully 16 times in the last Congress by the Republican majorities in both chambers to overturn regulations promulgated during the Obama administration.
However, Republicans were in control of both chambers in the last Congress and their actions were supported by President Trump.
Repealing the SALT regulation would undermine a portion of the 2017 Tax Cuts and Jobs Act that Republicans passed and if any legislation were to clear Congress, it would face a presidential veto.
