High-Tax States Challenge Constitutionality of Cap on SALT Deduction

  • United States
  • 07/25/2018
  • Duane Morris LLP & Affiliates. © 1998-2018 Duane Morris LLP. Duane Morris is a registered service ma

Four states—New York, Connecticut, Maryland and New Jersey—have brought a suit in federal court to invalidate the recently adopted cap on the state and local tax deduction, commonly referred to as the “SALT” deduction. The suit claims that the cap on the SALT deduction violates the U.S. Constitution by constraining the states’ sovereign right to make decisions on whether and how much to tax their residents and how to invest those funds.

The Tax Cuts and Jobs Act, passed by Congress and signed into law by President Trump at the end of 2017, overhauled the federal tax system. The reform included across-the-board cuts to individual tax rates, an increase in the standard deduction and elimination or limitation of most itemized deductions. The SALT deduction—which allows individuals to deduct their state and local (1) real and personal property taxes and (2) income or sales taxes—is now capped at $10,000 for both single and married filers under the new tax law. State and local taxes had previously been fully or significantly deductible since the adoption of the 16th Amendment in 1913.

In their suit, these high-tax states claim that their residents will be disproportionately affected by the new cap on the SALT deduction by raising their residents’ federal income taxes while lowering the tax burden of residents in low-tax states. They also claim that the resulting higher federal tax liability will cause a reduction in home values in their states, further harming their residents and tax base.

These states, in addition to other high-tax states like California and Illinois, have also passed or are considering legislative remedies to the new cap on the SALT deduction. Each state has used a different legislative workaround in order to offset the loss of the full SALT deduction. For example, in New York, the state has created its own charitable funds to which its residents may contribute and claim both a federal and state charitable deduction, while providing an 85 percent credit for such donations against state income taxes in the year following the contribution. There are no new limitations on the federal charitable deduction under the new tax law, and thus a larger charitable deduction can offset a reduced SALT deduction. The IRS has issued a notice that it plans to challenge these state workarounds by issuing new regulations.

It is unclear at this time whether high-tax states will succeed in court or through legislation in challenging the cap on the SALT deduction, but it is unlikely that there will be clarity before 2018 tax season.

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