Second Circuit Holds That States Have Standing to Challenge Cap on SALT Tax Deduction Because of Lost Local Tax Revenue

In New York v. Yellen, No. 19-3962 (2d Cir. Oct. 5, 2021), the Second Circuit holds that four states had standing to challenge the $10,000 cap on the federal income tax deduction for money paid in state and local taxes (SALT) because of the impact on local real estate sales and consequent lost tax revenue.

The federal income tax has always allowed a deduction of state and local taxes. Until 2017 a taxpayer could “deduct all state and local real and personal property taxes as well as either all state and local income taxes or all state and local sales taxes.” But in the 2017 Tax Act, Congress capped the SALT deduction at $10,000. The States of New York, Connecticut, Maryland, and New Jersey sued the U.S. Treasury, contending that the cap violates Article I § 8 and the Tenth and Sixteenth Amendments.

The Treasury moved to dismiss the complaint under Fed. R. Civ. P. 12(b)(1) for lack of standing and other jurisdictional grounds, as well as under Fed. R. Civ. P 12(b)(6) for failure to state a claim. The district court denied the jurisdictional argument but granted dismissal on the merits. The Second Circuit affirms.

“The question of standing therefore turns solely on whether the Plaintiff States have sufficiently alleged an injury in fact.” Their theory of standing, relying on Wyoming v. Oklahoma, 502 U.S. 437 (1992), is that “the SALT deduction cap is estimated to cause them to lose at least hundreds of millions of dollars of revenue from property taxes and real estate transfer taxes.” In the 1992 case, the Supreme Court held that Wyoming could sue Oklahoma over a protectionist state law that required 10% of coal burned in the state to be mined in Oklahoma, thus cutting into Wyoming’s revenue. “[T]he Oklahoma law reduced the demand for Wyoming coal, causing Wyoming to lose significant revenue from severance taxes, which were assessed as a percentage of the fair market value of all coal mined in the state.”

The Treasury argued that Wyoming represents only “a very narrow exception to the general rule that a reduction in tax revenues constitutes a generalized grievance that is not cognizable for purposes of standing.” Nevertheless, the panel holds that the “exception” to the rule applies here: “The Plaintiff States allege that the SALT deduction cap, among other effects, makes homeownership more expensive for taxpayers whose state and local tax liability exceeds $10,000: the cap prohibits taxpayers from deducting the full amount of their property taxes from their federally taxable income, thereby increasing their federal income tax liability. Because it makes homeownership more expensive, the cap reduces demand in the housing market, causing lower prices and fewer sales, and leads to specific losses in tax revenue derived from property and real estate transfer taxes.”

Nor is the alleged loss in tax revenue purely speculative. “New York provided a specific estimate that the SALT deduction cap will cause New York’s real estate transfer tax revenue to decrease by $15.3 million in 2019 and $69.2 million in 2020 … Maryland specifically estimated that the 2017 Tax Act would cause Maryland’s real estate transfer tax revenue to decrease by $52.3 million in two years … And New Jersey supplied expert declarations estimating that the 2017 Tax Act would cause New Jersey’s real estate transfer tax revenue to decrease by a total of $105.1 million in 2019 and 2020.” (The panel also holds that the lawsuit does not run afoul of the Anti-Injunction Act because it falls into the exception of “tax claims that the plaintiff could not assert elsewhere.”

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