4 States Sue U.S. Federal Government Over State & Local Tax Deduction Limit

The States of Connecticut, Maryland, New Jersey, and New York filed a joint lawsuit against the United States government on 17 July 2018, alleging that the $10,000 limitation imposed on the federal tax deduction for state and local taxes by the Tax Cuts and Jobs Act (TCJA) is unconstitutional.

The suit was filed in the U.S. District Court for the Southern District of New York, and includes as defendants the U.S. Treasury Secretary and Commissioner of Internal Revenue. 

New York, New Jersey and Connecticut, which are high-tax states whose taxpayers will be significantly affected by the new limit, formed a coalition in January to challenge the limit.  Maryland joined the coalition in May. 

Related: Repayments Under U.S. Payback Agreement No Longer Deductible

The states argue that the limit violates the 10th and 16th Amendments to the Constitution, and also Article 1, section 8. The complaint notes:

“[T]he new cap effectively eviscerates the SALT deduction, overturning more than 150 years of precedent by drastically curtailing the deduction’s scope. As the drafters of the Sixteenth Amendment and every subsequent Congress have understood, the SALT deduction is essential to prevent the federal taxing power from interfering with the States’ sovereign authority to make their own choices about whether and how much to invest in their own residents, businesses, infrastructure, and more-authority that is guaranteed by the Tenth Amendment and foundational principles of federalism.” 

The states also allege that Congress violated Article 1, section 8, by attempting to “coerce the states into lowering their taxes and cutting the services those taxes support.” The complaint includes an economic analysis that the states argue shows the limit will result in raising taxes on residents, decreasing home values, and making it more difficult for states to raise the revenue they need to provide essential services.

Constitutional experts expressed doubt that the lawsuit will be successful, but also believe that it will advance and be heard at some point. When that might be is unknown. However, a rapid resolution is unlikely, and taxpayers should assume that their state and local tax deductions will be limited to $10,000 for 2018.

How This Impacts Mobility

Companies that gross up for taxable relocation must take account of the reduced state and local tax deduction, which will negatively affect some transferees. Those transferees whose taxes are not reduced under the TCJA may be under-withheld, and may have inadequate gross-ups. Companies who do not already do so may face pressure to revisit gross-ups at year end for those transferees who consider the gross-up inadequate.

Related: U.S. Treasury & IRS to Address State Tax Deduction 'Workarounds'

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