House Democrats push to block IRS rules against state SALT workarounds

A group of House Democrats is renewing its challenge to the state and local tax deduction cap by trying to halt regulation that restricts state legislation targeting the deduction cap.

It’s the latest skirmish in the ongoing challenge to the $10,000 cap on state and local tax deductions, which was established in 2017 as part of the Tax Cuts and Jobs Act.

An April letter sent to the heads of the House subcommittee that helps oversee the IRS budget seeks to prohibit any funds from being used for "regulatory guidance or rulings that restrict the ability of state governments to enact legislation or policies that provide relief to taxpayers" from the SALT deduction cap. Rep. Mikie Sherrill, D-N.J., wrote the letter, which was also signed by Reps. Josh Gottheimer, D-N.J.; Tom Malinowski, D-N.J.; Katie Porter, D-Calif.; and Tom Suozzi, D-N.Y.

The $10,000 cap is set to expire at the end of 2025, but many Republicans have said they want to make it permanent.

The cap is unpopular with state and local issuers, especially among high-tax entities, who argue it limits their ability to raise taxes and contributes to fiscal stress.

Several efforts by Congressional Democrats to overturn the deduction cap have failed, and any remaining measures this year likely depend on the success of a reconciliation bill.

In April, the U.S. Supreme Court declined to hear an appeal from four states, including New York and New Jersey, who had challenged the deduction as unconstitutional because they said it interferes with their sovereign authority to levy and collect taxes.

With court challenges exhausted and legislation stalled, the five Democrats in April sent the letter to Reps. Mike Quigley, chair of the House Appropriations Subcommittee on Financial Services and General Government and Rep. Steve Womack, the committee’s ranking member.

They asked the lawmakers to include language in the FY23 budget that would stop the IRS from barring state SALT deduction cap workarounds.

Since 2018, dozens of states have floated and enacted various workarounds, including giving an individual state tax credits for charitable contributions. In 2019, the IRS banned the move.

In November 2020, however, the IRS indicated it would allow another workaround. That one applies to taxpayers who receive pass-through income from a business — most U.S. businesses are taxed as pass-through, or flow-through entities — with the state granting the owners a tax break or credit to offset the tax on the pass-through income. The move would essentially allow the taxpayer to claim their SALT payments as businesses expenses.

Since, then, 20 states have enacted the policy, with legislation pending in other states. Missouri lawmakers last week sent its governor a bill creating the pass-through entities.

The Democrats in their letter ask that the IRS be banned from using any of its funds to block either the charity or pass-through workarounds "among others."

“Particularly at a time when high cost-of-living states continue to see prices skyrocket, the IRS should not be using appropriated funds to prevent those very states from delivering critical relief to their residents,” the letter said. “This is not just an individual taxpayer issue, but also one significantly affecting the availability of high-quality public services for years to come. The SALT deduction cap specifically punishes states and localities that make large investments in public goods such as K12 education, green infrastructure, and first responders."

Separately, Malinowski and Porter in February introduced the Supporting Americans with Lower Taxes Act. The bill restores the SALT deduction for those making less than $400,000 a year, while increasing the cap for those making between $400,000 and $1 million. The bill remains in the Committee on Ways and Means and the Committee on Energy and Commerce, where it was referred after introduction.