Connecticut joined three other northeastern states in a lawsuit Tuesday contesting new limits on federal tax deductions — aimed primarily at a dozen states that voted against President Trump in 2016.
Connecticut joined Maryland, New Jersey and New York in contesting new limits on the state and municipal tax payments that filers can deduct on their federal income tax returns. Gov. Dannel P. Malloy, who announced in late January that a multi-state court challenge was in development, has called the tax changes crafted by the Republican congressional majority a political assault on blue states.
The lawsuit, which was filed Tuesday morning in U.S. District Court in New York, argues the new limits effectively undermine states’ rights under the U.S. Constitution to set their own tax policies.
In other words, it disproportionately punishes Connecticut and other states that rely heavily on state income and municipal property taxes to pay for government programs and services.
In some communities in Fairfield County and in Long Island, for example, many residents pay far more than $10,000 annually in real estate tax alone.
With high property and income tax burdens, a significant number of Connecticut taxpayers rely on deductions that far exceed $10,000. According to IRS data, more than 700,000 taxpayers in Connecticut claim about $13.6 billion in state and property deductions on their federal 2014 federal returns. State tax officials say the aggregate claim here now is closer to $16 billion.
“Perhaps most concerning, this law discriminates against Connecticut taxpayers, who stand to lose over 10 billion dollars in state and local tax deductions,” Malloy said in a press release. “Hundreds of thousands of residents could see a tax increase even as their property values decrease.”
The federal tax code revisions were codified in 2017 as part of a nationwide tax reform. The revisions curtailed the state and local tax (SALT) deductions and drew immediate criticism from wealthy, blue states like Connecticut, New York, and New Jersey. The states announced their intention to sue in January, arguing that the deductions unfairly affected 12 states with high property and income taxes. According to New York Gov. Andrew Cuomo, all 12 of those states voted for Hillary Clinton in the 2016 Presidential Election.
In the months following the tax code revisions, the Connecticut General Assembly and the Malloy administration responded to the federal laws by instituting a series of state tax changes in hopes of cushioning the blow.
One provision established a new Pass-Through Entity Tax which would allow small businesses to report their business’s income and their personal earnings collectively through their personal income tax returns. This would allow them to pay the same tax rate, but report their business’s earnings through a separate state tax — thereby reducing the personal income they would report on their federal return.
A second provision allows municipalities to provide a property tax credit to taxpayers who make voluntary donations to a “community-supporting organization” approved by the municipality. While the federal deduction for state and local taxes could not exceed $10,000, the rationale is that some or all of that payment also could be deducted from federal taxes by making the charitable donation.
The changes received support from Democrats and Republicans in the General Assembly, but drew a quick response from the Internal Revenue Service and the Treasury Department, which announced that they intend to issue regulations to stop Connecticut from getting around the new federal limitations.
In addition to jeopardizing the sovereign authority of states and unfairly burdening taxpayers in wealthier states, the lawsuit filed Tuesday argues that the federal tax obligations could harm the real estate market in those areas and have serious economic consequences.
“Despite massive economic promises from Republicans, real wages have actually decreased since the passage of the tax cut. At the same time the deficit has exploded by $1.5 trillion, providing a convenient excuse for GOP lawmakers to pursue their longtime goal of gutting Medicare, Medicaid and Social Security,” Malloy said. “I am proud to stand with my colleagues across the country in fighting against the discriminatory impacts of this shortsighted and damaging Republican law on our states.”