Hamilton Gives Cuomo His Shot: States Sue Over Federal Tax Cap (3)

Four Democratic-led northeastern states sued the Trump administration to invalidate the new $10,000 cap on the federal tax deduction for state and local taxes, but the chances for success are dim.

And a divided Congress is unlikely to revisit the cap, lawmakers and practitioners told Bloomberg Tax.

New York, New Jersey, Connecticut, and Maryland claim the sweeping 2017 federal tax law (Pub. L. No. 115-97) “targeted” the states and overturned more than 150 years of precedent. The state and local tax deduction is essential to prevent federal tax powers from interfering with constitutionally guaranteed state rights, according to the lawsuit.

The tax law resulted from a “hyper-partisan and rushed process” that will disproportionately harm taxpayers in the four states, the states said in announcing the lawsuit.

New York Gov. Andrew M. Cuomo (D) told reporters July 17 that the SALT cap was double taxation, “un-American,” and intentionally designed to hurt Democratic states.

Cuomo, citing Abraham Lincoln, Alexander Hamilton, and James Madison, said the cap is “violative of the Founding Fathers’ vision” of federalism.

According to the complaint, filed July 17 in Manhattan federal court, the new cap on the SALT deduction will make it more difficult for the four states to maintain their taxation and fiscal policies, thus “hobbling their sovereign authority to make policy decisions without federal interference.“

The lawsuit alleges that the SALT cap violates the 10th and 16th Amendments to the Constitution and provisions that prohibit Congress from exerting undue influence to coerce states to adopt policies preferred by the federal government.

‘Little Chance of Success’

Cuomo said the case was “so strong,” but others said it has no chance of passing legal muster.

“This lawsuit has little chance of success,” Edward A. Zelinsky, the Morris and Annie Trachman Professor of Law at Yeshiva University’s Benjamin N. Cardozo School of Law, told Bloomberg Tax in an email.

“While the U.S. Supreme Court has an historic record of invalidating state and local taxes under the Commerce Clause and other constitutional provisions, the Court has never struck a federal tax on constitutional grounds,” he said. “Since the adoption of the 16th amendment, authorizing the federal income tax, the U.S. Supreme Court has never struck a federal tax on constitutional grounds.”

Joseph Bishop-Henchman, executive vice president of the Washington-based Tax Foundation, said the lawsuit was more of a political move than a legal one.

“A judge is unlikely to rule that the SALT deduction cap violates either the Equal Protection Clause or the Tenth Amendment,” he said in a statement. “The concern that high state taxes might harm the competitiveness or attractiveness of a state like New York or Connecticut is a valid one, but the solution lays with revisiting those state tax rates, rather than meritless litigation.”

“The lawsuit is tilting at windmills,” Richard D. Pomp, the Alva P. Loiselle Professor of Law at the University of Connecticut School of Law, told Bloomberg Tax in an email.

“It is better politics than constitutional law,” he said. “Federal tax provisions never affect all states equally but disproportionately benefit some and hurt others. The states should spend their time and resources examining their own tax systems and how to make them fairer in light of the federal changes. Can you imagine how the newly constituted Supreme Court will deal with this case should it ever reach them?”

Latest Effort by States

The lawsuit is the latest effort by high-tax states to fight back against the new federal tax law. New York was the first to enact workarounds earlier this year when it passed a new charitable deduction and a voluntary payroll tax. New Jersey and Connecticut have also enacted workarounds, and the first of three California bills to allow taxpayers to make charitable contributions advanced through its first Assembly committee in June. Illinois shelved its plan at the end of May.

It is unclear whether the IRS will allow the state programs. The U.S. Treasury Department and the IRS said in a May 23 notice that the agency will issue proposed regulations on the issue. Notice 2018-54 also informs taxpayers that federal law controls the characterization of the payments for federal income tax purposes regardless of the characterization of the payments under state law.

The IRS in an email said it doesn’t have any updates on the status of the regulations promised by Notice 2018-54 and declined to comment on the pending litigation.

John J. Flanagan (R), Majority Leader of the New York Senate, criticized Cuomo for trying to sue his way out of high taxes. In a statement, he said the governor hasn’t done enough to lower state taxes.

Significant Impact

The impact of the SALT cap will be significant in the four states that filed the lawsuit. New York estimates that the cap will raise federal taxes in the state by $14.3 billion in 2018 and an additional $121 billion between 2019 and 2025. The cap will cause Connecticut taxpayers to lose an estimated $10.3 billion in SALT deductions in 2018, and will increase Connecticut taxpayers’ federal income tax liability by approximately $2.8 billion in 2018, according to a statement from Gov. Dannel P. Malloy (D) and Attorney General George Jepsen (D).

In Maryland, about 500,000 state residents will lose $6.5 billion in SALT deductions, according to Attorney General Brian E. Frosh (D).

In New Jersey, the SALT cap will increase federal taxes for residents by $3.1 billion, according to Martin Poethke, New Jersey’s Office of the Treasury’s Director of Revenue and Economic Analysis.

The lawsuit said 13 percent of New York taxpayers, 12 percent of Maryland taxpayers, and 11 percent of New Jersey taxpayers will experience a net increase in federal taxes because of the tax act, but only 5 percent of taxpayers in Florida and 2 percent of those in North Dakota will see their net federal taxes increase.

New Jersey Delegation

New Jersey’s Democratic U.S. senators and a Republican congressman split along party lines in response to the lawsuit, but it appears uncertain that Congress will revisit the cap even if there is a “Blue wave” in November.

Rep. Tom McArthur (R-N.J.) said the state was wasting time and tax dollars. “I am unimpressed by the lawsuit,” he said. “I think it is a political charade for political reasons for a highly political governor.”

“This lawsuit is predicated on the idea that somehow it was targeting blue states – it’s just political nonsense,” McArthur said.

“Governor Murphy just worked overtime to raise taxes in New Jersey by more than one billion dollars and cut school aid in a meaningful way around South Jersey, while the federal Tax Cuts and Jobs Act I supported will save New Jersey families and businesses $9 billion dollars per year,” he continued.

Sen. Cory Booker (D-N.J.) said SALT “should be a fair tax, not a raid on certain states in order to give corporations massive tax breaks.”

“We’re going to turn over the House and the Senate and pass a more equitable, fair tax plan focused on economic growth,” he said, referring to the November mid-term election.

Sen. Robert Menendez (D-N.J.) said “the reality is that this is the longest serving provision of our federal tax law.”

“It violates the states’ rights to ultimately set their own tax policy,” Menendez said. “And, in addition to that, I think it was a pure, political hit against states like New Jersey.”

“Either we will win legally in the lawsuit or we will sustain our ability to have the state and local property tax credit that we created through charitable institutions that 32 other states have in the country and, if not, maybe legislatively, depending on what happens in November,” Menendez said.

The case is New York v. Mnuchin, S.D.N.Y., No. 18-cv-6427, 7/17/18.