A New York U.S. District Court recently dismissed a case that challenged federal limits on state and local tax deductions. Certain high tax states have long taken issue with the tax reform change that placed a $10,000 “cap” on individual taxpayer deductions for the combined total of state and local property, income, and sales taxes. The opinion issued in late September deals another blow to efforts seeking to overturn the provision. In June, the IRS put an end to state attempts to bypass the cap through workarounds such as state tax credits. The latest development means that for the time being, the state and local tax (SALT) cap is here to stay.
The Basics of the SALT Cap Case
Connecticut, Maryland, and New Jersey joined the state of New York in raising a legal question over whether the SALT cap (established under the tax reform law) unfairly targeted certain high tax states, as residents in those states would be the most affected.
In a suit dating back to July 2018, the states argued that Congress overstepped its bounds by making a change that would affect the states’ taxes. The states also alleged that the SALT cap would harmfully reduce the states’ real estate transfer tax revenues. Moreover, the states argued that the cap makes owning a home more expensive because owners cannot deduct as much in property taxes. When the cost of owning a home become more expensive, it decreases the value of real estate. Home owners may delay selling their houses, for example, because of the limits on the deduction.
The federal government moved to dismiss the case on the grounds the states do not have a legal claim to fight the cap. It called the tax impact estimates too speculative.
What the Summary Judgment Tells Us About the SALT Cap
Although Judge J. Paul Oetken (appointed by President Obama) ultimately sided with the federal government’s request to dismiss the case, his opinion holds a few points of interest:
1. The States Had a Legal Claim to Make the Case - Judge Oetken agreed with the state argument that an economic impact may be felt by the states as a result of the SALT cap. He also weighed in on the fact that there is a specific jurisdictional question at the root of the case—whether the federal government can impose a SALT cap.
2. The Federal Government’s Powers to Tax Permit It to Limit SALT Deductions - In his opinion, Judge Oetken was not convinced that there is a constitutional principle that prevents Congress from imposing the SALT cap. The constitution gives the federal government the power to lay and collect income taxes and to grant exemptions from that tax. Judge Oetken dismissed the idea that states’ sovereign authority to tax was disrupted by the ruling, noting that states can choose to adapt their policies to work around federal tax policies and limitations (such as by lowering state tax rates).
3. State Claims of Injury Might Be Overblown - Judge Oetken also noted that the states’ claims concerning individual taxpayer impact were based on flawed inputs. The states compared what taxpayers would have paid in taxes without the SALT cap to the same tax liabilities with the SALT cap. But as has been well documented, the totality of the tax reform law included certain provisions to counteract its tax cuts with other provisions to “pay for” those tax breaks. Judge Oetken argued that the tax reform law’s varied provisions might have looked very different had the SALT cap never been on the table, so the comparison is not a sound one.
It is unclear whether the states will appeal the opinion. New York governor Andrew Cuomo said afterwards in a statement that New York was considering an appeal. The Attorney General for Connecticut called the decision “disappointing,” and said his state was in talks with the other plaintiffs to evaluate the next step.
For the time being, residents in high tax states should consult with their tax advisor about tax planning strategies under the assumption that the SALT cap will remain in place until the provision (along with other provisions affecting individual taxpayers) expires at the end of 2025.
To learn more about the impact of this court opinion, please contact us.
Published on October 15, 2019