Noonan’s Notes Blog is written by a team of Hodgson Russ tax attorneys led by the blog’s namesake, Tim Noonan. Noonan’s Notes Blog regularly provides analysis of and commentary on developments in the world of New York tax law.

More SALT Deduction Lawsuits!

But earlier this month, state and local governments filed two separate lawsuits to overturn the IRS' June 13 final regulations. These two lawsuits are in addition to the previous 2018 SALT cap lawsuit filed by a group of states that attacked the legality of the SALT deduction cap in the first place, as discussed here and here.

In the first suit, State of New Jersey, State of New York, and State of Connecticut v. Steven T. Mnuchin in his official capacity as Secretary of the United States Department of the Treasury and Charles P. Rettig, in his official capacity as Commissioner of the Internal Revenue Service, three states--New Jersey, New York, and Connecticut-- filed their complaint in the U.S. District Court for the Southern District of New York on July 17, 2019. The states argue in this federal suit that the final regs violate the Administrative Procedure Act (APA) and the Regulatory Flexibility Act and thus should be declared unlawful and vacated.

Specifically, the complaint alleges that the final regs violate the APA because they are “inconsistent with the plain meaning of section 170,” [of the Internal Revenue Code of 1986] and are “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law” and “in excess of statutory jurisdiction, authority, or limitations, or short of statutory right.” The states further argue that the rules are not in compliance with the Regulatory Flexibility Act because “the IRS failed to publish an initial and a final regulatory flexibility analysis required by the law.”

The final regs require taxpayers to subtract the value of state and local tax credits for charitable giving from their federal charitable contribution deduction. Connecticut, New York, and New Jersey have enacted legislation allowing localities to establish community funds that can accept charitable contributions. In exchange for making a donation, taxpayers can receive a tax credit toward their property tax liability.

Another lawsuit, also filed July 17, 2019, this time by the Village of Scarsdale, New York, (“the Scarsdale lawsuit”—not to be confused with the Scarsdale diet of the late 1970s ) claims the IRS’ final regs “usurp the lawmaking function and purport to unilaterally impose the current administration’s political will in violation of clear statutory limits” and in doing so would cause charitable reserve funds set up in New York to “suffer irreparable harm.” The Scarsdale complaint further notes that ”the Final Regulations purport to override this basic and longstanding principle by treating state and local tax credits as separate items of consideration solely for purposes of determining the amount of a taxpayer’s federal charitable contribution deduction.” Scarsdale’s charitable gifts reserve fund received over $500,000 in 2018 contributions prior to the issuance of the Final Regulations, of which $25,000, or 5% of these contributions, was made available to Scarsdale for use as it saw fit for its residents, including for the administration of its charitable gifts reserve fund. Since the IRS issued the Final Regulations, no further contributions have been made, depriving Scarsdale of the 5% of non-creditable contributions that it would have otherwise received above and beyond any real property taxes assessed and collected.

Scarsdale is a member of the Coalition for the Charitable Contribution Deduction, which comprises Nassau, Suffolk, and Westchester counties; 17 municipalities; 17 school districts; and eight state and countywide professional and advocacy organizations. The coalition was formed to sue the IRS if it implemented regulations blocking charitable contribution SALT cap workarounds. New York State Assembly member Amy Paulin (D), who organized the Coalition for Charitable Contribution Deduction, said in a July 17 press release that "the denial of charitable deductions for donations to charitable reserve funds disproportionately hits communities like mine."

"In trying to satisfy the whims of this administration without running afoul of powerful interests, the IRS regulations strayed far from the law that they were supposed to interpret. These regulations will cause real harm for villages like Scarsdale and taxpayers across the country struggling to remain in the communities they fell in love with and to send their children to the same nurturing, high-quality schools," she further stated in this press release.

Other state officials argue that the SALT cap was designed to target states like Connecticut, New York, and New Jersey. Attorneys general from the three states and California previously urged the IRS to scrap the proposed regulations, which would have also ended charitable contribution workarounds. They asserted that the regs “are arbitrary and capricious, an exercise in law-making rather than statutory interpretation, and contrary to public policy” in their October 11, 2018 comments to proposed Reg -112176-18.

“There was absolutely nothing new, nothing novel, nothing unique about what we did in this state,” New Jersey Attorney General Gurbir Grewal said at a July 17 press conference. “About 33 states have a program similar to this one. In fact, there are over 100 similar programs that offer tax credits to taxpayers who make charitable contributions to qualifying institutions.”

Grewal said that the IRS blessed those programs in 2010. “But when New Jersey, New York, and Connecticut decided to establish the very same type of program, the IRS decided to change its mind . . . this is yet another unfair attack on our states coming out of Washington,” he said. New York Governor Andrew Cuomo (D) said in a July 17 press release that the IRS should not be used as a political weapon.

"The final IRS rule flies in the face of a century of federal tax law that says state choices to provide tax incentives for charitable donations do not affect the federal deductibility of those gifts. It will — for the first time and solely in the name of retribution — require taxpayers to subtract the value of state or local tax credits from their federal charitable deduction," Cuomo said to the press. 

Stay tuned for the next lawsuit!

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