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Tax Cuts and Jobs Act

​ Federal Court Dismisses States’ Challenge to SALT Deduction Cap ​

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

A federal district court has dismissed four states’ constitutional challenge to the state and local tax (SALT) deduction cap enacted as part of the Tax Cuts and Jobs Act (TCJA, ​PL 115-97​). (State of New York v. Mnuchin, (DC NY 9/30/19) 124 AFTR ¶2019-5302) The district court found that the states failed to plausibly allege that the SALT cap meaningfully impaired their ability to pursue their own preferred tax policies and, therefore, it had no basis for concluding that the SALT cap was unconstitutionally coercive.

​Code Sec. 164(a)​ allows a deduction for the payment of certain taxes, including: (1) state and local, and foreign, real property taxes; (2) state and local personal property taxes; and (3) state and local, and foreign, income, war profits, and excess profits taxes. But, ​Code Sec. 164(b)(6)​ limits an individual’s deduction for state and local taxes (SALT) to $10,000 ($5,000 in the case of a married individual filing a separate return) for the aggregate amount of such taxes paid during the calendar year (the SALT cap). This limitation applies to tax years beginning after December 31, 2017 and before January 1, 2026.

The federal government derives its authority to “lay and collect Taxes” from Article I, section 8 of the U.S. Constitution. (U.S. Const. art. I, § 8, cl. 1) But, this grant of authority has not displaced the concurrent taxing power of the states. (Gamble, ​(2019) 139 S. Ct. 1960​)

In 1913, after the Sixteenth Amendment was ratified, Congress enacted the first federal income tax of the 20th century. (Act of Oct. 3, 1913, ch. 16, §II) Generally, that statute allowed a deduction from federal taxable income “all State, county, school, and municipal taxes” paid within the year (SALT deduction). (Act of Oct. 3, 1913, ch. 16 §II(B))

Although a SALT deduction has remained in the tax code, it has been amended at various times. For example, in 1964 Congress enumerated the types of state and local taxes that were deductible from federal taxable income (Revenue Act of 1964, ​PL 88-272​), and in 1986 eliminated the deduction for state and local sales taxes. (Tax Reform Act of 1986, ​PL. 99-514​)

The four state plaintiffs, Connecticut, Maryland, New Jersey and New York, concerned that the SALT cap would impair their ability to pursue their own preferred tax policies, filed suit against the federal government alleging that the SALT cap violated the federalism principles undergirding the U.S. Constitution.

The district court dismissed the four states’ constitutional challenge to the SALT cap enacted as part of TCJA. The district court found that the states failed to plausibly allege that the SALT cap meaningfully impaired their ability to pursue their own preferred tax policies and, therefore, it had no basis for concluding that the SALT cap was unconstitutionally coercive.

The district court rejected the states’ arguments that (1) the SALT deduction has a special historic status and any attempt to eliminate or substantially curtail it upset the constitutional balance of state-federal power; and (2) that the SALT cap represented an unlawful effort by Congress to wield its regulatory authority in a way that coerced specifically targeted states to change their tax policies.

The states’ first argument failed because under Article 1, section 8, the federal government’s power to lay and collect taxes is exhaustive and embraces every conceivable power of taxation. (​Brushaber v Union Pacific RR Co., (S Ct. 1916) 3 AFTR 2926​) Therefore, Congress holds plenary power under the Constitution to tax income and to grant exemptions from that tax. (​Lyeth v Hoey, (S Ct 1938) 21 AFTR 986​) And, that plenary power knows no restriction except where one is expressed in or arises from the Constitution. (​Bennett, (S Ct 1914) 3 AFTR 2897​)

The district court recognized that the SALT cap is in many ways a tax law novelty. But the states  failed to persuade the court that this novelty sufficiently established that the SALT cap exceeded Congress’s broad tax power under Article I, section 8 and the Sixteenth Amendment.

The states’ second argument, that Congress was attempting to coerce specifically targeted states into bringing their tax policies in line with those of the federal government, was also rejected.

Even assuming Congress enacted the SALT cap hoping to prompt high-tax states to lower their taxes, an otherwise valid federal law does not offend the Constitution simply because it seeks to affect state policies. (South Dakota v Dole, ​(1987) 483 U.S. 203​) The federal taxing power, like the spending power, gives the federal government considerable influence even in areas where it cannot directly regulate. (Nat’l Fed. of Indep. Business v. Sebelius (NFIB), ​(S Ct 2012) 109 AFTR 2d 2012-2563​) But, just as Congress may impose conditions on federal spending to encourage federally preferred state-level policies, it may also influence the states by enacting a tax on an activity that it cannot authorize, forbid or otherwise control. (NFIB)

Basically, the states failed to plausibly allege that the SALT cap’s effects were so harmful that Congress left the states with no real option but to acquiesce in the federal government’s preferred state and local tax policies and, therefore, was unconstitutionally coercive.

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