Governor Murphy, Attorney General Grewal Sue IRS Over SALT Deduction Rule

Governor Phil Murphy and state Attorney General Gurbir Grewal announced Wednesday that the state has filed a lawsuit that seeks to strike down a new IRS rule that would prevent New Jersey residents from obtaining a full federal charitable deduction whenever they contribute to local governments and other qualifying institutions. The lawsuit aims to restore the state’s “SALT deduction work-around” which was designed to preserve the full federal income tax deductibility of state and local taxes.

The Trump Administration’s tax overhaul enacted in 2017 placed, for the first time, a $10,000 cap on the federal deduction for state and local taxes (SALT). The SALT cap disproportionately impacted taxpayers in New Jersey, and other high tax states such as Connecticut, and New York.

Connecticut and New York joined New Jersey in the lawsuit.

To ease the burden to New Jersey taxpayers, Murphy signed into law legislation (S1893, now P.L.2018, c.11.) which allows residents to make charitable contributions to qualifying local institutions, and to receive partial tax credits of up to 90 percent against their local property tax bills when they did so.

At least 33 states have developed over 100 similar charitable contributions programs that provide a state or local tax benefit in return for a charitable contribution to a qualifying entity under Section 170(c). These programs incentivize individuals to donate to causes ranging from natural resource preservation and aid for higher education to domestic violence shelters. The IRS consistently treated charitable contributions made pursuant to these programs as fully deductible under federal tax law.

But when New Jersey, New York, and Connecticut decided to establish such programs, the IRS issued a new rule aimed at nullifying the tax benefit New Jersey was making available to charitable givers. The Final Rule requires taxpayers to subtract the value of any state and local tax credits they receive for charitable giving from their federal charitable contribution deduction.

The New Jersey-led lawsuit describes IRS’s action as a “radical break” from historic precedent, and describes the rule as arbitrary, outside the agency’s statutory authority, and a violation of the federal Administrative Procedures Act.

In addition to being unlawful, the complaint asserts, the rule threatens economic harm to New Jersey and other states by discouraging charitable giving, and by depriving such local entities as school districts, municipalities, and counties of important funding. Indeed, because the law signed by Gov. Murphy does not provide dollar-for-dollar tax credits, contributions made pursuant to that program would yield a net increase in local revenues, which local governments could use on vital services like education.