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States file lawsuit over SALT deductions cap

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New York, New Jersey, Connecticut and Maryland sue federal government over $10k SALT deduction cap

Four states opened the newest front in the war against the state and local tax deduction cap when they sued the federal government, saying the cap violated the Constitution. Reactions to the lawsuit from associations of counties in those states line up as pretty tepid.

The tax reform bill signed into law in 2017 caps the federal tax deduction that homeowners can take for their state and local taxes at $10,000. It disproportionately affects homeowners in coastal states with higher average property taxes, including New York, New Jersey, Connecticut and Maryland, all of which are plaintiffs.

The suit, filed in the Southern District of New York last month, focuses on the limits of the federal government’s tax powers established by the 16th Amendment and federalism established by the 10th Amendment.

“When the Constitution was ratified, it was widely understood that the federal government could not abrogate the States’ (sic) sovereign tax authority, and that the federalism principles embedded in the Constitution would constrain the federal government’s tax power,” according to the suit.

“Since Congress enacted the first federal income tax in 1861, Congress has provided a deduction for all or a significant portion of SALT in every federal income tax law, respecting federalism constraints on its taxing power and the concurrent tax authority of the sovereign States(sic). This uninterrupted practice provides strong evidence that the federal government lacks constitutional authority to drastically curtail the deduction.”

Michael Sanderson, executive director of the Maryland Association of Counties, said changes to the SALT deduction have upended county management.

“It’s a big unknown, this has been the most difficult fiscal prediction I’ve seen state and local governments have to make in more than 25 years,” he said. The bedrock upon which financial forecasting is based has changed.

“You try and run the numbers on what a proposed change will do, typically you did it in a static way,” he said. “This is a big enough change to affect people’s decisions on how to declare their income and how to file, and it leaves us in a total mess down here.”

“Every way you slice this issue, Maryland has been on the list of states most aggressively affected,” he said.

Sanderson said the suit seemed to be the logical step in what has become standard operating procedures in politics.

“It seems to be part of the political landscape now that aggrieved political parties seek a court remedy for what historically would be a political remedy,” he said. NACo and 20 other local government associations formed a coalition, Americans Against Double Taxation, to oppose the proposed elimination of the SALT deduction.

John Donnadio, executive director of the New Jersey Association of Counties, said he doesn’t expect much from the suit, or at least no time soon.

“At the end of the day that could take years to work through the courts,” he said. “In the meantime, the IRS will be promulgating regulations (on the new tax structure), states will be promulgating regulations, and there’s a lot that needs to be figured out as a practical matter.”

Likewise, he has not spent much time studying the complaint, saying there were more immediate concerns for the association.

New York and New Jersey are exploring ways to circumvent the cap, including establishing charitable funds to which residents could pay their local and school taxes and receive a federal tax credit. The New Jersey association is telling counties and municipalities to hold off on that step.

“Until the IRS or the (New Jersey) State Department offers some guidance, we’re advising people not to do this,” Donnadio said. “There are folks who want to move forward with this, but I’m not aware of any local government that has set one up, and I don’t think they should.”

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