District Court Rejects State End-Run of Federal Tax SALT Limitations with State Creditable "Charitable" Contribution (4/8/24)

In New Jersey v. Mnuchin, ___ F.Supp. 3d ___,  2024 WL 1386080, 2024 U.S. Dist. LEXIS 59122  (S.D. N.Y. 3/30/24), CL here and GS here, the Court rejected now familiar attacks, including APA and Chevron. This time the attacks come from the states rather than those who fear the administrative fear (either in reality or to stir the base). The complaint of the states (including New York and Connecticut components as named plaintiffs) is that Treasury failed both substantively (improper interpretation a la Chevron) and procedurally in promulgating the Final Rule interpreting § 170 (the charitable deduction provision). The Final Rule denies a charitable contribution deduction where the state gives a quid pro quo in the form of a state and local tax credit. The state tax credit was simply a state end-run around the 2017 Tax Act “SALT” (state and local tax) deduction limitation. 

The Court described the Treasury response to the state legislation (Slip Op. 2-3, footnotes omitted and cleaned up):

On June 13, 2019, the Treasury Department and the Internal Revenue Service ("IRS") promulgated a new regulation (the "2019 Final Rule") governing the availability of charitable contribution deductions for payments made to state and local governmental units where the taxpayer receives or expects to receive a state or local tax credit in return. The new regulation involves an interpretation § 170, which in part governs the deduction of charitable contributions on federal income tax returns.

The 2019 Final Rule provides that "the amount of the taxpayer's charitable contribution deduction under [S]ection 170(a) is reduced by the amount of any state or local tax credit that the taxpayer receives or expects to receive in consideration for the taxpayer's payment or transfer." 26 C.F.R. § 1.170A-1(h)(3)(i).

In this action, Plaintiffs seek a declaration that the 2019 Final Rule is invalid under the Administrative Procedure Act, 5 U.S.C. § 706. Plaintiffs contend that Defendants — Treasury, the IRS, and their officers (the "Government") — exceeded their statutory authority in promulgating the 2019 Final Rule, and that the issuance of the Rule was arbitrary and capricious.

The Court dispensed with threshold issues such as 

• Standing (Slip Op. 16-29), 
• Anti-Injunction Act (Slip Op. 29-32) , and 
• Violation of the Regulatory Flexibility Act (Slip Op. 32-36).

Moving to the Merits of the Claim under the APA (Slip Op. 35-59), The Court first holds that the Regulation easily passes Chevron’s two-step analysis.  Key points:

• Finding at least ambiguity, the Court says (Slip op. 37): “As an initial matter, although the 2017 Tax Act caps SALT deductions at $10,000, it does not speak to Plaintiffs' efforts to circumvent that restriction through the device of programs by which charitable contributions made to state and local governmental units are exchanged for state tax credits, and then listed on the taxpayer's federal income tax return as charitable deductions.”
• The law is clear that a quid pro quo negates a charitable deduction. The Court said that in the circumstances where the state provides the quid pro quo by a state tax credit negates the charitable nature of the gift. Or, at least at Step One, the statutory text does not foreclose the interpretation and may thus be said to be ambiguous leaving some interpretive room for the agency.

Moving to Chevron Step Two, the Court finds (Slip Op. 43-56) the interpretive delegation to Treasury in both § 7805(a) and the ambiguity in the statute on the precise point (as determined at Step One).

Finally, the Court finds the Final Rule not arbitrary and capricious, a procedural test. The states’ claims were that Treasury (Slip Op. 57, cleaned up):

(1) impermissibly relied on IRC § 164, an entirely different Code section which Congress did not intend it to consider when interpreting IRC § 170"; (2) did not consider the decline in charitable contributions that would result from the 2019 Final Rule; and (3) changed its interpretation of "charitable contribution" without adequate explanation.

Specifically, Treasury adoption of the Final Rule was procedurally adequate.

JAT Comments:

1. I don’t believe that the outcome would be different if the Supreme Court were to eliminate or circumscribe deference. The Final Rule is so logically correct that it is the best interpretation of the statute (I think).

2. The district judge in this case (Judge Paul G. Gardephe of SDNY) was well-served by the controlling Second Circuit opinions that deal with Chevron and APA issues. In my view, based on my reading over the years, the Second Circuit has done a demonstrably better job on these issues than the other Circuits, even the DC Circuit which is supposed to be more expert on administrative law issues.

3. On the SALT limitation, see e.g., Julie Zauzmer Weil, Fight over deduction for state and local taxes snags GOP tax bill (WAPO 7/24/23), here:

President Donald Trump’s signature tax law limited that deduction to $10,000. That sum affected fewer people in red states where tax rates tend to be lower and many more people in blue states with higher rates, including New York, New Jersey and California.

4. The CourtListener docket entries are here.