The recent capping of a federal write-off for state and local taxes — long cherished by residents of high-tax states like New Jersey — is constitutional, a federal judge has ruled, dealing a major blow to Gov. Phil Murphy’s push to have the cap nullified in the courts.
In a 37-page decision issued yesterday, Judge J. Paul Oetken sided with the federal government; he dismissed arguments New Jersey and three other states made last year in response to a major 2017 federal tax overhaul by President Donald Trump and the then-Republican Congress.
Among other changes, the new tax law placed a $10,000 limit on the long-standing tax exemption for state and local taxes known as SALT. In the lawsuit, the four states — New Jersey, Connecticut, Maryland and New York — said they were unconstitutionally targeted by federal lawmakers who were seeking to coerce them into lowering their respective state tax rates.
But in yesterday’s ruling, Judge J. Paul Oetken said the states’ arguments simply fell short.
“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,” his ruling said.
A spokesman for New Jersey Attorney General Gurbir Grewal declined comment yesterday, and it remains to be seen whether any of the states will appeal. But Murphy, a first-term Democrat, did weigh in, issuing a statement that said he was “disappointed” with the judge’s decision.
Murphy ‘proud to fight back’
“As the (Trump) Administration weaponizes our nation’s tax code at the expense of our already overburdened taxpayers, Attorney General Grewal and I have been proud to fight back alongside other states,” Murphy said.
The 2017 tax overhaul reduced individual income-tax rates and slashed the burden for corporations and those leaving behind large estates. Changes were also made to several exemptions and deductions, including the standard deduction, which was increased. But to help pay for those tax reductions, the new limit on the SALT write-off was also put in place.
The results of the tax changes — which went into effect for the first time in tax year 2018 — varied widely among tax filers. They hit many New Jersey residents hard since the combination of high local property-tax bills and state income taxes could no longer be fully deducted from their federal taxes — thus increasing the amount of income subject to the new federal tax rates.
In their lawsuit, New Jersey and the three other states argued the lack of a full SALT deduction would harm their respective real-estate markets and effectively coerce state officials to levy lower taxes. The states also cited powers granted in the 10th Amendment of the U.S. Constitution to argue that Congress overstepped its own taxing authority by capping what had previously been an unlimited deduction.
In the decision to dismiss the suit, Oetken credited the states for making a strong case that the exemption for state and local taxes is a “novelty” of the tax code that has a long history going back over a century. But he said Article One, Section Eight of the Constitution trumps any of the claims made by the states related to the 10th amendment.
Judge sees ‘no constitutional problem’
“The bare fact that an otherwise valid federal law necessarily affects the decisional landscape within which states must choose how to exercise their own sovereign authority hardly renders the law an unconstitutional infringement of state power,” the ruling said.
The judge also disputed the states’ contention that the SALT cap would force them to lower tax rates against their will or face economic damages, including reduced revenue from real-estate transfer taxes.
“Even if, as the States contend, Congress enacted the SALT cap in order to exert downward pressure on state and local tax rates, such a motive poses no constitutional problem as long as the states remain free ‘not merely in theory but in fact’ to set their own tax policies,” Oetken wrote in the ruling.
The court challenge was not the Murphy administration’s only effort to combat the effects of the 2017 tax law, including the SALT cap. Last year, the governor and lawmakers also worked to establish a so-called workaround for New Jersey residents by reclassifying payments for services like law enforcement and K-12 schools as charitable contributions instead of property taxes.
The workaround attempted to take advantage of the full federal tax deduction that is still allowed for charitable contributions. But it remains the subject of another court battle between the Murphy administration and the federal government as the Internal Revenue Service has issued rules that would effectively block the reclassification of property-tax payments whenever taxpayers are receiving something of significant value in return for their contributions. The New Jersey SALT workaround allows local governments to award property-tax credits worth up to 90 percent of a charitable contribution. But the IRS issued rules saying a charitable contribution can only be deducted in full from federal taxes when the contributor receives something back that is worth 15 percent or less than their original contribution.
Allowing Trump administration ‘to continue its assault’
Murphy referred to that ongoing legal clash in the statement he issued yesterday in response to Oetken’s ruling.
“We’re disappointed by today’s decision permitting the Trump Administration to continue its assault on New Jersey’s hardworking taxpayers,” Murphy said.
“Our administration will continue our challenge against discriminatory rulemaking by the IRS and take all necessary actions to restore full SALT deductibility for our residents,” he said.
Meanwhile, an effort to provide SALT relief for small-business owners and the operators of so-called “pass-through entities” by reclassifying their income has stalled in the state Assembly after winning unanimous approval from the Senate.