Second Circuit: SALT cap is not unconstitutional

The $10,000 maximum deduction for state and local taxes is upheld by the Second Circuit.
By Laura Lee Mannino, CPA, J.D., LL.M.

The Second Circuit affirmed a district court's holding that although four states had standing to challenge the cap on the deduction for state and local taxes (SALT), the states failed to prove that the cap is unconstitutional.

Facts: Sec. 164 permits a federal deduction for taxes paid to state and local governments. Prior to enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, taxpayers were permitted to deduct the full amount of SALT taxes paid or incurred. However, the TCJA placed a cap on the deduction, limiting it to $10,000. Four states — Connecticut, Maryland, New Jersey, and New York — filed suit in federal district court challenging the constitutionality of the cap.

In addition to arguing the cap is constitutionally sound, the government claimed that the district court lacked jurisdiction to hear the case. The district court established its jurisdiction; however, it held that the cap did not violate the Constitution. The four states appealed to the Second Circuit.

Issues: The government argued again on appeal that the court lacked jurisdiction to hear the case. The basis for its jurisdictional argument was twofold: First, the government contended that the states did not have standing to proceed with their claim. To have standing, a plaintiff must have suffered an injury, the injury must be traceable to the defendant, and the injury would be remedied by a judicial holding in the plaintiff's favor. Second, the government asserted that the suit was barred by the Anti-Injunction Act (Sec. 7421(a)), which provides that no suit with the purpose of restraining the assessment or collection of any tax may proceed.

The states argued that the cap is unconstitutional because the SALT deduction is constitutionally mandated by Section 8 of Article 1 and the 16th Amendment. Alternatively, the states argued that because the cap coerces the states to lower taxes or cut spending, it violates the 10th Amendment, which provides that powers not granted to the federal government are reserved to the states.

Holding: Addressing the jurisdictional issues first, the Second Circuit held that the states had standing and the case was not barred by the Anti-Injunction Act. Regarding the latter, the court noted that the Anti-Injunction Act does not bar a tax claim if the plaintiff has no alternative legal way to challenge the tax provision, such as a suit for refund. Since the states had no other way to assert their claims, the Second Circuit held that the Anti-Injunction Act did not bar the case.

Regarding standing, the government did not dispute that if the states suffered an injury, such injury could be traced to the government, and a judicial outcome in favor of the states would remedy such injury. Accordingly, the only remaining question regarding standing was whether the states were injured by the cap on the SALT deduction. The states argued that the cap makes home ownership more expensive, resulting in lower prices, fewer sales, and reduced revenues from real estate transfer taxes. Further, the states provided specific estimates of the magnitude of such reduced revenues. New York estimated that the SALT cap would cause its real estate transfer tax revenue to decrease by $15.3 million in 2019 and $69.2 million in 2020, Maryland estimated its transfer tax revenue to decline by $52.3 million over two years, and New Jersey estimated a reduction of $105.1 million over the same period. Finding the chain of economic events presented by the states to be "realistic," the Second Circuit held that the loss of revenue is an injury, thereby giving the states standing to sue the government.

Turning to the merits of the case, the court noted that the states' claim that the SALT deduction was constitutionally mandated was primarily based on the fact that Congress had not eliminated or curtailed the SALT deduction since its inception — at least, not until 2017. However, neither Article 1, the 16th Amendment, nor the 10th Amendment specifically mentions the SALT deduction, nor do they place any limitations on Congress's power to change the deduction. From a historical perspective, the Second Circuit noted that Congress does not seem to view its authority relating to the SALT deduction to be limited in any way. The court specifically noted that two tax provisions enacted in 1986 (the alternative minimum tax and removal of state and local sales taxes from the SALT deduction) and one in 1990 (the "Pease" limitation on all itemized deductions) also effectively curtailed the availability of the deduction, and it concluded that the Constitution does not limit Congress's power to impose a cap.

The Second Circuit found no evidence that the cap infringes on state sovereignty in violation of the 10th Amendment. The court was unpersuaded by the argument that the SALT cap targeted particular states. It said that Congress is permitted to use its taxing authority to provide incentives that encourage some states to adjust their policies so long as the incentives do not amount to pressure or compulsion to adopt the federal policy. Such compulsion was present in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), where the Supreme Court held a federal incentive was unconstitutionally coercive because failure to adopt it would cost a state 10% of its budget. Although the Second Circuit acknowledged the loss of state tax revenue resulting from the SALT cap, it found the amounts to be too small in relation to an entire state's budget to be considered coercive in violation of the 10th Amendment.

  • New York v. Yellen, No. 19-3962 (2d Cir. 10/5/21), aff'g No. 18-CV-6427 (S.D.N.Y. 9/30/19)

Laura Lee Mannino, CPA, J.D., LL.M., is an associate professor of taxation, St. John's University, Queens, N.Y.



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