States Sue Federal Government Over State and Local Tax Deduction

New York, New Jersey, Connecticut and Maryland have sued the federal government in an attempt to overturn the newly enacted $10,000 cap on state and local tax deductions, which was included in the Republican tax reform plan last year.

As part of the Tax Cuts and Jobs Act (TCJA), the amount taxpayers may claim on Schedule A for all state and local sales, income and property taxes together may not exceed $10,000 ($5,000 for married taxpayers filing separately).

These states believe that the state and local tax deduction cap unfairly targets Democrat, high-tax states like New York.  The lawsuit contends that the $10,000 cap interferes with the states’ sovereign authority to make their own choices about whether and how much to invest in their own residents, businesses, infrastructure and more, thus a violation under the 16th and 10th amendments.

Furthermore, the states argue the state and local tax deduction cap will raise the federal tax liability of millions of taxpayers. By increasing the federal tax burden on taxpayers in targeted states, the states believe that it will be more difficult for the states to maintain their taxation and fiscal policies. That means they cannot make policy decisions without federal interference, therefore, a violation of the 16th amendment.

States are considering taking legislative and other actions to try to mitigate the consequences of the state and local tax deduction cap. However, the IRS has now signaled they will take action to stop those efforts. States argue the federal government is not only targeting their states, but also seeking to interfere with the states’ sovereign policy authority over taxation and fiscal policy.

Will the states prevail in this lawsuit?  Time will tell.  The final decision to be determined is if the state and local deduction allowed under federal law is a constitutional right, as the states believe it is, or a benefit allowed to these states, as the federal government views it.  

For questions about these law changes or other state and local tax matters, please contact us.