High-tax states had little luck this year challenging a cap on local tax deductions, and 2020 is shaping up to be just as frustrating for them.
The IRS has left states little room for a legislative maneuver around the $10,000 federal cap on individual taxpayer deductions for state and local taxes, and court challenges appear to have little prospect of success. Likewise, a renewed effort by Democrats on Capitol Hill this month to challenge the cap in the House appears doomed in the Senate.
“I don’t see what else they could do,” Richard Auxier, a researcher at the Tax Policy Center in Washington, said.
Some states could try business-related workarounds—following the lead of such states as Connecticut and Louisiana—but that targeted tactic helps a relatively small number of affected taxpayers.New Jersey most recently tried a similar approach involving pass-through businesses. The solution states want—lifting the deduction cap for individuals—is far more elusive.
The House, led by Democrats, voted Dec. 19 to remove the individual cap for 2020 and 2021, but Republican leadership in the Senate has already said it isn’t likely to consider the bill (H.R. 5377), and the White House threatened a veto.
Prospects for repeal in the future “would depend on who’s in the White House after 2020,” said Sheila Reynertson, an analyst at New Jersey Policy Perspective, which advocates for working class families.
The 2017 tax law, which imposed the individual-deduction cap, didn’t limit business deductions for state and local taxes—making business-related workarounds likely both the next best thing and last option for states opposed to the cap.
“It’s a reasonable alternative,” said Bruce Ely of Bradley Arant Boult Cummings LLP. “I think you’re going to see a number of states adopt these entity-level taxes next year.”
New Jersey Gov. Phil Murphy (D) has repeatedly called the cap a “weaponized” version of the tax law, one that singles out high-tax Democratic states like his own and nearby states.
The state joined New York and Connecticut in suing to take down a June IRS rule (T.D. 9864) that blocks state charitable donation-based measures to let individuals get cap-free tax deductions that avoid the SALT deduction cap.The suit is pending in a New York federal court, but likely “dead in the water,” said Hayes Holderness, an assistant law professor at the University of Richmond.
“The ultimate target here is the federal SALT cap, and unfortunately for the states, the federal cap is lawful,” Holderness said.
Murphy is still committed to fighting the law, a spokesperson told Bloomberg Tax, although she declined to detail how.
“The challenge is most likely to succeed only in continuing to shine a light on the states’ frustration with the SALT cap,” Holderness said. “That attention may lead to legislative changes in the future, but this case is unlikely to directly change the law.”
The three states, along with Maryland, lost an earlier court challenge to the cap itself, but a federal judge threw out their lawsuit in September. The states filed an appeal.
A spokesman for the New York state Senate majority said Democrats there will “continue fighting” the tax law, but he didn’t specify how.
“It affects state policy but it’s a federal law change,” Auxier of the Tax Policy Center pointed out. “They would have to change federal law, which means they would have to get different people elected to office.”
A California lawmaker who tried unsuccessfully to enact a workaround in 2018 hasn’t ruled out another try, although she acknowledges the federal regulations make it more difficult.
“I am open to any approach that can withstand legal scrutiny while aiding California families and the vital services so many depend on,” said Assemblywoman Autumn Burke (D), chair of the Revenue and Taxation Committee.
Burke’s bill would have allowed taxpayers to donate to nonprofits, state schools, and a state college grant program in exchange for a state credit that was also meant to qualify for a federal deduction. The federal regulations undercut the approach that the bill took.
“Even with these federal roadblocks, however, I remain committed to exploring creative ways of addressing the fallout of the SALT cap,” Burke said.
Her measure died in the senate in 2018, but former Gov. Jerry Brown (D) vetoed another bill that did in the same session. Former Senate President Pro Tempore Kevin de Leon’s (D) measure would have expanded a program in place since 2014 that gives taxpayers a 50% state tax credit for contributions that ultimately go to a state scholarship program for low-income students.
De Leon is no longer in the Legislature. No lawmakers tried to enact SALT cap workarounds in 2019.
Midwest Still Watching
Earlier this year Midwest states, by and large, were waiting to see what California, New York, and Connecticut did concerning the cap—and that’s unlikely to change in 2020.
Minnesota probably won’t explore any ways to address the cap next year.
Instead, lawmakers will be focused on “getting out quick to hit the campaign trail,” said Mark Haveman, executive director of the Minnesota Center for Fiscal Excellence, a nonpartisan research organization.
Illinois, also a high-income tax state, likely won’t focus on it, either.
Workaround bills were proposed in 2018, but they had logistical problems, Carol Portman, president of Taxpayers’ Federation of Illinois, a government watchdog that advocates for taxpayers and businesses, said.
Lawmakers simply “ran out of time and perhaps to a lesser extent political will” after Treasury released guidance on efforts in other states, she said.
“I don’t think they have a lot of options left,” Reynertson said.
—With assistance from Laura Mahoney in California and John Herzfeld in New York.