Connecticut’s lawsuit over SALT deduction cap dismissed by federal court

United States District Judge J. Paul Oetken dismissed a lawsuit by Connecticut and three other states against the Donald Trump administration, the U.S. Department of Treasury and the Internal Revenue Service over its cap on state and local property tax deductions, commonly known as SALT.

The judge concluded “Congress enacted the SALT cap pursuant to its broad tax powers under Article 1, section 8 and the Sixteenth Amendment. The cap, like any federal tax provision will affect some taxpayers more than others and, by extension, will affect some states more than others.”

Connecticut, New York, Maryland and New Jersey filed the suit after President Trump signed the Tax Cuts and Jobs Act, which capped the amount of state and local taxes that could be deducted from federal income taxes at $10,000 per couple and $5,000 per individual.

The states argued the tax unfairly punished high tax, Democratic-leaning states as a way to coerce them into reforming their tax policies, according to the court decision.

Connecticut officials estimated the SALT cap would increase Connecticut’s taxpayers’ liability by $2.8 billion in 2018 and cost Connecticut residents $10.3 billion in SALT deductions in 2019, according to a report from the Office of Legislative Research.

The average state and local tax deduction in 2015 was $19,664, according to report from the Hartford Courant.

Connecticut Attorney General William Tong issued a statement saying his office was in “close coordination with other states to consider next steps.”

“The SALT cap is an abusive and discriminatory tax hike on Connecticut,” Tong said. “This disappointing decision makes it harder for our state to protect its taxpayers from the disproportionately harmful effects of Trump’s tax law.”

Although Connecticut joined other states in filing suit, it attempted two workarounds of the tax cap.

The first allowed residents to make “voluntary payments to a municipally-approved nonprofit that is organized exclusively to support municipal spending,” and allow taxpayers to file those payments as charitable donations. 

That workaround didn’t fly with the Internal Revenue Services, which quickly shot down the idea from Connecticut and other affected states.

Connecticut’s second workaround was more successful but is not available to everyone. This fix used a pass-through entity tax which levied the top income tax rate. 

The pass-through entities were then able to deduct their tax payments from their federal taxes and would be credited back 93 percent of the 6.99 percent tax paid to the state.

That fix appears, thus far, to have passed muster with the IRS, but the 2019 budget enacted a quick revenue grab by lowering the amount of money credited back to businesses from 93 percent to 87 percent, rankling business owners and creating complicated quarterly accounting woes.

Connecticut’s lawsuit was spearheaded by former Gov. Dannel Malloy and then Attorney General George Jepsen. 

At the time, Malloy called the SALT cap “repugnant” and said “this law discriminates against Connecticut taxpayers, who stand to lose over 10 billion dollars in tax deductions. Hundreds of thousands of residents could see a tax increase even as their property values decrease.”

Part of the concern over the SALT cap is that it will drive more high-wealth individuals to states with lower property taxes and no state income taxes since they will no longer be able to deduct those payment from the federal tax returns.

“The States have cited no constitutional principle that would bar Congress from exercising its otherwise plenary power to impose an income tax without a limitless SALT deduction,” Oetken wrote in his decision.