Even after the policy debate and subsequent changes implemented under the tax and spending megabill last summer, the SALT cap on the deduction for state and local taxes remains a charged issue.

High-tax states have been searching for ways to offset the cap’s financial effects since it was introduced by the 2017 tax overhaul. A recent case, State of New Jersey v. Bessent, should serve as a warning that the federal government continues to evaluate state-level workaround strategies — and when it comes to workarounds involving charitable giving, courts have continued to uphold the Internal Revenue Service’s position prohibiting these contribution-for-credit programs designed to offset the effects of the SALT cap.

While a ruling by the U.S. Court of Appeals for the Second Circuit backing the IRS’ rejection of a state cap workaround is not surprising, taxpayers should pay attention to ongoing federal attention with respect to these and other workaround efforts.

SALT Cap Workarounds: Background

The 2025 tax legislation temporarily raised the $10,000 SALT cap to $40,000, adjusted annually by 1% through 2029. The $10,000 cap is scheduled to be reinstated in 2030.

The $40,000 cap phases out for taxpayers with modified adjusted gross income that exceeds $500,000, with a minimum $10,000 floor regardless of income. The cap will be reduced by 30% of any excess of the taxpayer's MAGI over the threshold amount, which will also be adjusted for inflation.

Because of the phase-out, higher-income taxpayers may see limited usefulness from the increase to $40,000. This, in turn, highlights the value of state-level workarounds.

To offset the federal-level SALT cap, the states of New York, New Jersey and Connecticut and the town of Scarsdale, New York, created programs that would allow taxpayers to contribute to state-sponsored charities and receive state or local tax credits for those contributions. While the IRS has not challenged pass-through entity tax workaround strategies, it has issued regulations that require taxpayers who take federal charitable contribution deductions to reduce the deduction by the amount of any state and local tax credit received for the contributions.

The local entities sued to overturn these regulations based on the argument that they were arbitrary and capricious under the Administrative Procedure Act and that the IRS exceeded its statutory authority with the regulations.

New York Challenge and 2nd Circuit Case

Initially, a U.S. District court analyzed the plaintiffs’ claims and found that only New York and Scarsdale had standing to sue (because New Jersey and Connecticut had paused their programs following the release of IRS regulations). The court analyzed the regulations under the now-overturned Chevron standard and granted summary judgment to the IRS. The plaintiffs appealed to the Second Circuit.

The court first addressed the Ant-Injunction Act, which generally prohibits suits that are filed for the sole purpose of prohibiting the federal government from collecting taxes. The court allowed the case to proceed despite Ant-Injunction Act challenges because the plaintiffs had no alternative route for challenging the IRS regulations.

The court also held that the IRS did not exceed its statutory authority by treating the state-level tax credits as benefits that the taxpayers would receive in return for the charitable contributions. Because the taxpayers did receive such benefits, the court found that the contributions more closely resembled trades and were less like gifts.

The court then considered the IRS’ statutory interpretation of IRC Section 170 under the new Loper Bright standard following the overturning of the Chevron defense doctrine. The court concluded that the IRS was correct in its interpretation. Further, the court found that the IRS regulations were not arbitrary and capricious under the Administrative Procedure Act because the IRS had demonstrated that it considered all relevant factors, provided detailed explanations for its policy choices and drew a rational, informed connection between their rule and the facts.

The crux of the decision was that the state and local tax credits amounted to a benefit received in return for the charitable contribution — so it was proper for the IRS to require that any otherwise-available federal deduction be reduced by the value of the tax credit.

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