States Sue Federal Government Over Unconstitutionality of SALT Deduction Limitation
Since the enactment of Trump’s Tax Cuts and Jobs Act (“TCJA”), a partisan battle has ensued between the federal government and state Democrat leaders over the Act’s limitation on the state and local tax (“SALT”) deduction.
In this latest round of political hostility, four states with relatively high income tax rates and a lot at stake for its residents (New York, Connecticut, Maryland and New Jersey) have taken to the courts to void the limitation by arguing that it is unconstitutional.
The New SALT Deduction Limitation
Under the newly-enacted Tax Cuts and Jobs Act (“TCJA”), starting with the 2018 tax year, state and local property and sales taxes are deductible only when paid (or accrued) in carrying out a trade or business, and state and local income taxes are not allowable as a deduction.
However, an individual taxpayer can claim an itemized deduction of up to $10,000 for state and local property taxes not paid (or accrued) in carrying on a trade or business, and state local income taxes paid (or accrued) during the tax year. Foreign real property taxes are no longer deductible.
Drawing the Battle Lines
Soon after the enactment of the TCJA, several states implemented legislation designed to work around the SALT deduction limitation. New York, for instance, now offers “charitable gifts trust funds” to which taxpayers can make deductible contributions and claim a tax credit equal to 85% of the charitable donation. New Jersey now offers a similar charitable deduction option, and California is currently working on the same type of workaround.
More recently, the IRS fired a warning shot in Notice 2018-54, stating that it intends to propose regulations addressing the “federal income tax treatment of transfers to funds controlled by state and local governments (or other state-specified transferees) that the transferor can treat in whole or in part as satisfying state and local tax obligations.” The proposed regulations will “make clear that the requirements of the Internal Revenue Code, informed by substance over-form principles, govern the federal income tax treatment of such transfers,” and will “assist taxpayers in understanding the relationship between the federal charitable contribution deduction and the new statutory limitation on the deduction for state and local tax payments.”
States Go to Court
On July 17, four states, Connecticut, Maryland, New York and New Jersey, filed a lawsuit in a New York federal court, arguing that limiting the deduction conflicts with constitutional principles that protect states’ rights.
They further argue that the limitation was spurred by a highly partisan process and that it causes disproportionate injury to residents in democrat-majority states. The lawsuit also claims that the limitation will artificially depress home values in the four states that are filing the suit.
Finally, the states allege that the limitation will hamper their ability to afford essential state services for the residents, such as police, hospitals, schools, hospitals, and vital construction and maintenance projects.
What This Means U.S. Expats
In truth, most U.S. expats will most likely not be affected by the SALT deduction limitation, because they are no longer domiciled in a U.S. state. However, some expats may potentially be affected – such as U.S. citizens who have recently moved abroad and are still considered temporarily domiciled in a state, or U.S. citizens living abroad who still have business concerns in the U.S.
In the bigger picture, since the Tax Cuts and Jobs Act is still relatively new, it may take some time to fully understand its impact on taxpayers. Our blog page will continue to monitor events related to the TCJA and its impact on expats moving forward.
By Ephraim Moss, Esq. & Joshua Ashman, CPA