The Tax Cuts and Jobs Act of 2017 (“TCJA”) was the most comprehensive overhaul of the Tax Code in over 30 years, but one of the most controversial changes was the limitation of the State and Local Tax (“SALT”) deduction. Prior to tax reform, taxpayers who itemized their deductions were eligible to deduct 100% of their state income tax or sales tax as well as their state and local property taxes. The SALT tax deduction especially benefited high-income taxpayers, as they were more likely to itemize their deductions, and they could take large SALT deductions on their tax returns. For taxpayers living in high-tax states, this was a substantial deduction, as property taxes alone could easily exceed $10,000 per year. According to the Tax Policy Center, the average SALT deduction claimed by taxpayers in the 2017 tax year was over $20,000 for high-tax states such as California, Connecticut, and New York. On the other hand, low-income taxpayers in low-tax states did not reap the benefits of the SALT deduction if they took the Standard Deduction as opposed to itemizing. The SALT deduction essentially acted as a Federal Government subsidy to high-tax states. The TCJA capped State and Local Tax deductions at a combined total of $10,000 beginning in the 2018 tax year. The SALT deduction cap is scheduled to sunset after December 31, 2025. As one could imagine, this was a huge blow to taxpayers living in high-tax states.
Since the enactment of the TCJA, many high-tax states, have voiced their concerns over the new SALT deduction limits. These high-tax states argue that they face increased pressure to lower state taxes, which would cut funding for state programs. In addition, they argue that the curtailed SALT deduction leads to a decrease in housing prices and property values, reducing tax revenue that the states earn on home sales. There is even anecdotal evidence that taxpayers in high-tax states will move to low-tax states, such as Florida or Texas, to alleviate the heavy burden of the TCJA SALT cap.
In a move to challenge the TCJA SALT deduction limits, four high-tax states, Connecticut, Maryland, New Jersey, and New York, filed a lawsuit (“New York v. Mnuchin”) in July of 2018 against Treasury Secretary Steven Mnuchin, IRS Commissioner David Kautter, and others, alleging that the $10,000 cap on State & Local deductions was “an unconstitutional assault on states’ sovereign choices.” On September 30th, 2019, U.S. District Court Judge Paul Oetken dismissed the lawsuit, ruling that the states failed to prove that the cap on State & Local deductions was unconstitutional or exceeded Congress’ power to tax under Article 1, Section 8 and the 16th Amendment. Oetken noted “an otherwise valid federal law does not offend the Constitution simply because it seeks to affect state policies.” In response, on November 26, 2019, the four states filed a notice of appeal in the U.S. Court of Appeals for the Second Circuit.
New York Attorney General, Letitia James, and New York Governor, Andrew Cuomo, are among the most outspoken critics of the TCJA’s capped SALT deduction. During a press release, Attorney General James asserted that “New York will not be bullied into paying more in taxes or changing its vital public investments because of Congress and the President’s partisan choices.” Governor Cuomo added, “New York is already the nation’s leader in sending more tax dollars to Washington than we get back every year, and we will not allow this administration to pick the pockets of hard-working New Yorkers to fund tax cuts for corporations and send even more money to red states. We will continue to fight this unconstitutional assault until it is repealed once and for all.”
If anything is certain, it is that the TCJA cap on State and Local Tax deductions will continue to be a hot topic for years to come.
Rachel Parsia, CPA is Manager of Tax & Advisory Content for Surgent CPE. She attended Penn State University, graduating with a master’s degree and bachelor’s degree in accounting, as well as a bachelor’s degree in finance. Before joining Surgent, she worked at KPMG and TE Connectivity Ltd. and has experience in Federal Tax, International Tax, and Tax Forecasting.