SALT Cap Bypass Appeal Challenges Move to Boost Federal Coffers

Three states challenging a Treasury rule that curbs their programs to circumvent the $10,000 cap on state and local tax deductions are set to argue in federal appeals court on Thursday in a case that could lower federal tax revenue to the benefit of high earners.

New York, New Jersey, and Connecticut—which have relatively high SALT obligations and wealthy residents who would benefit from greater SALT deductions—developed workarounds to the cap that took advantage of the federal income tax deduction for charitable donations.

But Treasury’s rule limits the available charitable contribution deduction where the donor earned equivalent SALT credits for their donations—in effect, replicating the once-unlimited SALT deduction.

The three Democrat-led states, with the Village of Scarsdale, N.Y., joining as a plaintiff, unsuccessfully sued on the ground that the rule is arbitrary and capricious under the Administrative Procedure Act.

Treasury is asking the US Court of Appeals for the Second Circuit to uphold dismissal of Connecticut’s and New Jersey’s claims for lack of standing, and to affirm the lower court’s ruling against New York’s APA claim. The Anti-Injunction Act bars the relief sought by the states because it would constrain the IRS from assessing or collecting taxes, the federal government said.

Greater SALT deduction caps and state-level plans for circumventing them can have a major impact on federal tax revenue.

“A certain type of very wealthy person can get around it, whereas your run-of-the mill upper-middle class person probably can’t,” William Gale, co-director of the Urban-Brookings Tax Policy Center, said of the current $10,000 deduction limit.

A full repeal of the cap would cost upwards of $1.2 trillion in federal tax revenue over the next ten years, according to TPC’s estimates. Removing the current cap’s “marriage penalty” by doubling the available deduction for joint filers would cost the federal government about $224.7 billion over the same period, with a majority of benefits flowing to top earners.

SALT Cap Tensions

The appeal coincides with negotiations among Republicans in Congress, who are planning the tax code’s largest shakeup since the 2017 law that introduced the $10,000 SALT cap during President Donald Trump’s first term.

The GOP used the provision at the time to pay for tax cuts, but in the near-decade since, the cap remains a wedge issue among lawmakers from both parties.

Rep. Andy Harris (R-Md.), leader of the conservative House Freedom Caucus, recently predicted that Congress will raise the SALT deduction cap. But the issue remains in flux, as some anti-SALT deduction Republicans consider them a subsidy for high-tax states and an incentive to increase local taxes.

The question of whether to raise the SALT deduction cap, considering its disproportionate tax benefits for wealthier taxpayers, also split the Democratic caucus during President Joe Biden’s term in office.

“One interesting feature of the SALT debate is that it is not, unlike some other issues, strictly a partisan or ideological disagreement,” said Garrett Watson, director of policy analysis at the nonprofit Tax Foundation. “The impacts of this very much vary by geography.”

Even if the GOP’s income tax bill were to significantly raise the cap, suits over the validity of state-level credit programs remain relevant because they set the terms of debate for future SALT fights, said Lauren Suarez, of counsel at RJS Law Firm.

“It’s good to have in case, down the road, another party, another person, comes forward and proposes anything similar,” Suarez said. “Waiting and seeing is the bigger thing, but you still have skin in the game watching these cases.”

Longstanding Programs

SALT credit programs now curbed by the Treasury rule at issue in the Second Circuit case had existed for decades before the deduction cap was introduced, said Brian Kirkell, leader of the state and local tax group in RSM US LLP’s Washington National Tax office.

“There have been Arizona programs where you can donate to your kid’s school and those earn you a SALT credit,” Kirkell said. “Those credits were like $100 or $500, but they created the model for other states to create this kind of open-ended creditability for charitable deductions.”

New York triggered a response from Treasury over the magnitude of its credit plan. But other smaller, historical programs also were impacted by federal enforcement efforts.

“There are credits here that have existed for generations of taxpayers and were never objectionable to Treasury,” Kirkell said. “They are all getting caught in the crossfire.”

The New York, New Jersey, and Connecticut attorneys general represent their respective states. Kostelanetz LLP and Baker & McKenzie LLP represent Scarsdale on appeal.

The case is New Jersey v. Yellen, 2d Cir., No. 24-1499, oral arguments scheduled 3/20/25.