Tax Cuts and Jobs Act

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The States of New York, Connecticut, Maryland, and New Jersey filed a federal court lawsuit this week challenging the constitutionality of the new $10,000 cap on the federal tax deduction for state and local taxes (SALT). The lawsuit, filed in the Southern District of New York, names as defendants the Secretary of the Treasury, the Acting Commissioner of Internal Revenue, the Internal Revenue Service, and the United States of America. The States allege that the SALT deduction cap, enacted as part of 2017 tax reform, violates numerous provisions of the United States Constitution, including the Tenth Amendment, the Sixteenth Amendment, and Article I, Section 8.

According to a press release issued by New York Governor Andrew M. Cuomo, the lawsuit argues that the new SALT cap was enacted to target New York and similarly situated states, that it interferes with states’ rights to make their own fiscal decisions, and that it will disproportionately harm taxpayers in these states. An analysis by the New York State Department of Taxation and Finance shows that the cap will increase New Yorkers’ federal taxes by $14.3 billion in 2018 alone, and an additional $121 billion between 2019 and 2025. A press release issued by Connecticut Governor Dannel P. Malloy similarly estimated that Connecticut taxpayers will lose an estimated $10.3 billion in SALT deductions in 2018, and will increase Connecticut taxpayers’ federal income tax liability by approximately $2.8 billion in 2018.

The SALT deduction cap has been one of the most controversial provisions of the 2017 tax reform legislation.  We previously wrote about efforts by some states, including New York and New Jersey, to pass laws providing for mechanisms to work around the cap. These “workarounds” would allow taxpayers to make payments to specified entities in exchange for a tax credit against state and local taxes owed.  In May, the IRS the Internal Revenue Service notified taxpayers that it would soon be issuing regulations addressing the deductibility of state and local tax payments for federal income tax purposes, and issued a not-so-subtle reminder that federal law controls the characterization of payments for federal income tax purposes regardless of the characterization of the payments under state law.

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Today the Internal Revenue Service notified taxpayers that it will soon be issuing regulations addressing the deductibility of state and local tax payments for federal income tax purposes. The IRS also reminded taxpayers that federal law controls the characterization of payments for federal income tax purposes regardless of the characterization of the payments under state law. These forthcoming regulations are targeted at efforts by some states, including New York and New Jersey, to pass laws providing for mechanisms to work around the newly-enacted federal cap on state and local deductions. These “workarounds” typically allow taxpayers to make payments to specified entities in exchange for a tax credit against state and local taxes owed.

The federal Tax Cuts and Jobs Act (TCJA) limited the amount of state and local taxes an individual can deduct in a calendar year to $10,000. The IRS said that the regulations, to be issued in the near future, will help taxpayers understand the relationship between federal charitable contribution deductions and the new statutory limitation on the deduction of state and local taxes. The IRS also warned that it is continuing to monitor other legislative proposals being considered to ensure that federal law controls the characterization of deductions for federal income tax filings. The limitation imposed by the TCJA applies to taxable years beginning after December 31, 2017, and before January 1, 2026.

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Our colleagues Stanley Barsky, Michael S. Bookbinder, and Eric J. Michaels have published an article for Law360 addressing provisions of the Tax Cuts and Jobs Act that significantly affect the federal income tax consequences of structures often used in domestic mergers and acquisitions. These are the pass-through provisions of Section 199A, provisions relating to treatment of carried interests, changes related to treatment of certain intellectual property, and imposition of tax (and withholding obligations) in connection with a foreign person’s sale of interests in a partnership that has effectively connected income. The act contains a number of ambiguities, which makes application uncertain, and we expect and hope for clarifying regulations to be issued and technical corrections to be enacted. Until then, taxpayers and their advisers must tread carefully, relying on legislative history and, in certain cases, pre-act authorities to determine the scope and application of these provisions. Their article is available here.

Our colleague Tiana R. Seymore has authored a client alert addressing several provisions in the Tax Cuts and Jobs Act which directly impact the workplace, including one that gives some employers a credit for providing paid family and medical leave if they meet specific requirements and another that eliminates certain tax deductions in sexual harassment and sexual abuse cases.  You can read Tiana’s alert here.

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