Connecticut, New Jersey, and New York yesterday announced lawsuits challenging U.S. Internal Revenue Service (IRS) and U.S. Treasury Department regulations that block attempts to circumvent the federal cap on the deductibility of state and local taxes (SALT).

The 2017 federal tax overhaul capped SALT deductions at $10,000 – a move of particular import in states like Maryland. In response, some states passed legislation to allow local governments to create charitable funds to pay for local services and offer property tax credits to incentivize residents to give. Those taxpayers could then write off the payment as a charitable deduction on their federal income tax return – cap free.

Under the final regulations, a taxpayer making payments to an entity eligible to receive tax-deductible contributions must reduce the federal charitable contribution deduction by the amount of any state or local tax credit that the taxpayer receives or expects to receive in return.

For example, if a state grants a 70 percent state tax credit pursuant to a state tax credit program, and an itemizing taxpayer contributes $1,000 pursuant to that program, the taxpayer receives a $700 state tax credit. A taxpayer who itemizes deductions must reduce the $1,000 federal charitable contribution deduction by the $700 state tax credit, leaving a federal charitable contribution deduction of $300.

The regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their charitable contribution deductions.

According to Governing:

The lawsuits allege that the IRS overreached its authority when it closed states’ charitable deduction loopholes. That’s because the ban applies to long-established state-run trusts that give out tax credits in exchange for donations for things like environmental preservation and charter schools. Dozens of states — not just high-tax states or those controlled by Democrats — have these trusts.

…

Given that the IRS and Congress have nipped and tucked the state and local tax deduction several times over the past 50 years, observers think it’s unlikely the constitutional argument will prevail.

In the meantime, Maryland Attorney General Brian Frosh has joined Maryland with Connecticut, New Jersey, and New York in suing the federal government over capping the SALT deduction. The ongoing case alleges that the new $10,000 SALT cap violates the U.S. Constitution’s Equal Protection Clause and the 10th Amendment, which protects states’ rights.

Useful Links

Governing: States Again Sue IRS Over Federal Tax Law

Previous Conduit Street Coverage: Feds Squash SALT Cap Workarounds

Previous Conduit Street Coverage: Local Tax Deduction Elimination: “SALT” In Maryland’s Wounds

Previous Conduit Street Coverage: Maryland Joins Three States In SALT Suit