LawFlash

Four States Sue Federal Government to Invalidate Cap on State and Local Tax Deduction

July 18, 2018

New York, New Jersey, Maryland, and Connecticut are seeking to invalidate the new $10,000 cap on the federal deduction for state and local taxes, alleging that the cap is unconstitutional, interferes with states’ rights to make fiscal decisions, and could cause a decrease in home values.

July 18, 2018

New York, New Jersey, Maryland, and Connecticut filed suit against the federal government on Tuesday to invalidate the new $10,000 cap on the federal deduction for state and local taxes, which was enacted as part of HR 1, the 2017 tax legislation formerly known as the Tax Cuts and Jobs Act.[1] The suit alleges that the state and local tax deduction is essential to prevent federal tax powers from interfering with constitutionally guaranteed state rights and that the cap is an “unconstitutional assault on states’ sovereign choices.”

Before 2018, taxpayers had an unlimited federal deduction for state and local taxes. With the enactment of federal tax reform in 2017, individuals and married taxpayers filing jointly who itemize deductions may now deduct only up to $10,000 annually for state and local income, property, and sales taxes. According to the suit, the cap on the state and local tax deduction will force New York taxpayers alone to pay an additional $14.3 billion in federal taxes this year, and another $121 billion through 2025.[2] New Jersey, Maryland, and Connecticut expect to experience similar effects. Additionally, the four states allege that the new cap is likely to substantially decrease home values in their states and impede the states’ ability to pay for essential services such as schools, hospitals, police, and road and bridge construction and maintenance.

New York, Connecticut, and New Jersey adopted state-level measures earlier this year that are meant to limit the impact of the cap on the state and local tax deduction. One such measure includes allowing taxpayers to fund local government by making deductible charitable contributions to specified funds in lieu of paying taxes. In May, the Internal Revenue Service announced that it would propose regulations aimed at states trying to circumvent the cap.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Chicago
Adam Beckerink
Matthew Mock
Laura Grace Mehzer

New York
Cosimo A. Zavaglia

Philadelphia
Justin D. Cupples
Ester Lee


[1] State of New York, 1:18-cv-06427, US District Court for the Southern District of New York (Manhattan).

[2] The cap is scheduled to expire in 2025.