States losing battle over SALT cap deduction

Arguments by northeastern states in court hearing later this month deemed a long shot by legal experts

Jun 13, 2019 @ 11:55 am

By Bloomberg News

New York, New Jersey and Connecticut have been fighting a new cap on state and local tax deductions ever since it was included in the 2017 Republican tax overhaul.

They are losing.

[More:Treasury deals final blow to states' SALT deduction workarounds]

The tax law capped the federal deduction for state and local taxes, or SALT, at $10,000. That set off campaigns to eliminate the provision by politicians in states with high income taxes and high property taxes, which tend to be Democratic states. It also set off an effort to find legal workarounds that would ease the sting of the SALT cap out of fear that high-earning residents would move out of state.

Now, most of those laws have been invalidated and those that remain are on shaky legal ground or taxpayers have decided they aren't worth the hassle.

Four northeastern states, including New York and New Jersey, will argue in a court hearing later this month that the cap infringed upon their constitutional right to tax. Legal experts, including those who would like to see the states win, have said the case is a long shot.

Members of Congress have introduced several bills to repeal or raise the cap. Such legislation might pass the Democratic-controlled House, but would die a quick death in the Republican-led Senate that has no interest in unwinding parts of their signature tax law.

The Treasury Department late Tuesday dealt the final blow. It issued regulations that prohibit programs in high-tax states that would allow filers to circumvent the law. Treasury said those programs allowed taxpayers to claim too many tax breaks.

States including Connecticut and New York have passed laws allowing residents to to donate to a state-created charitable fund instead of paying property taxes. That person would then get to write off the donation as a charitable gift on his or her federal taxes and get a state tax credit for some of that. The regulations killed these programs.

Democrats say Republicans targeted residents of states they control as a way to pay for the $1.5 trillion tax cut. Since the law was enacted, governors and lawmakers from high-tax states have decried the change as a GOP assault on Democratic strongholds.

"This Trump administration seems to wake up in the morning trying to think up ways to screw my state," Representative Bill Pascrell, a New Jersey Democrat, said in a statement Tuesday.

(More: SALT apocalypse predictions have not come true)

The victories for so-called blue states have largely been symbolic. The House Ways and Means Committee will hold a hearing on possible changes to the SALT cap later this month, that could lead to legislation raising the $10,000 limit. But Senate Finance Chairman Chuck Grassley has already said he won't take up any SALT-related bills in the Senate.

Even talking about the SALT cap could be a political liability for some Democrats, because most of the benefit goes to top earners at a time when the party's presidential candidates are focused on income inequality and new taxes on the wealthy.

About 9% of households would benefit from a repeal of the SALT cap, according to analysis from the Urban-Brookings Tax Policy Center. About 96% of the benefit goes to the top 20% of household by income, their data found.

Taxpayers in Connecticut and New York both still have options to skirt the SALT cap that Treasury didn't address in Tuesday's regulations. Connecticut allows owners of so-called pass-through businesses — such as partnerships, limited liability companies and S corporations — to take bigger federal deductions to absorb some of the hit from the SALT deduction limit. New York created a way for employers to shield their employees from the cap.

But the workarounds are narrowly tailored and don't apply to all taxpayers. Since the tax law kept business' SALT deductions unlimited, New York passed a law that lets companies opt in and essentially pay for their employee's state taxes.

It's hard to make it work practically, Jared Walczak, a senior policy analyst at the Tax Foundation said. It might be a great deal for a small company with similarly compensated employees, such as a hedge fund, but it's a lot harder for a large company

with a wide range of salaries to make it work, he said.

"Not many companies are willing to jump into" New York's workaround, Tom Corrie, a principal at accounting firm Friedman.

Connecticut's workaround for pass-throughs also faces hurdles. It's open to legal challenges and IRS officials have said they are considering issuing guidance to invalidate it. A lawsuit or regulations that kill the Connecticut plan could mean that taxpayers could have to pay more state taxes than they would have in the first place, Mr. Walczak said.

Despite the dim outlook for an immediate repeal of the SALT cap, Democrats have said they won't relent.

(More: SALT cap will affect nearly 10.9 million people)

"The federal government is continuing its politically motivated economic assault on New York," New York Governor Andrew Cuomo said in a press release. "We will pursue all options, including litigation, to resist this attack on our state and our taxpayers."

Lawyers for New York will make their case in front of a U.S. District Court next Tuesday.

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