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Attorneys general from New York and New Jersey filed a lawsuit against the U.S. Treasury Department on Wednesday challenging a decision by the federal agency to block a scheme developed by the state that would have allowed states and local taxes to be fully deductible as charitable contributions.

The complaint in the lawsuit alleged that the Internal Revenue Service violated federal law when it promulgated the new rule, which the suit called a “radical break with this historical precedent and practice.”

“Had Congress wished to eliminate the deductibility of charitable contributions when taxpayers receive state or local tax credits—upending decades of practice and adversely affecting programs in at least 33 states—it would have done so in clear terms,” the suit said.

It's the latest development in a string of legal challenges that have grown from the federal Tax Cuts and Jobs Act, passed by Congress in 2017. The law, in part, capped the deduction of state and local taxes at $10,000 for the first time, which lawmakers in high-tax states like New York have decried as a political attack from Republicans in Congress.

Among the law's major opponents has been New York Gov. Andrew Cuomo, who's argued on several occasions that the law has particularly disenfranchised people living in New York. Residents of Westchester County and Long Island commonly have state and local tax bills exceeding $10,000, for example, largely fueled by property taxes.

“The Trump administration's SALT policy is an economic civil war that helps red states at the expense of blue states,” Cuomo said Wednesday.

Before the federal tax law, those residents could deduct the full amount of their state and local tax burden from their federal taxes. The new cap, Cuomo has argued, is effectively a tax increase on those residents, who will now carry a higher federal tax bill.

As a workaround to the cap, lawmakers in New York created a new option that allowed taxpayers to receive tax credits in exchange for donating to a charitable fund operated by the state. The law also allowed local governments to establish such a fund.

That was intended to allow those donations, which would essentially act as a taxpayer's state and local tax payments, to be fully deductible from one's federal tax burden, as other charitable contributions are.

But the IRS, in a final regulation promulgated last month, said that scheme wouldn't be allowed. The rule requires taxpayers to reduce their charitable contribution deductions by the amount of any state or local tax credits they receive or expect to receive in return. It was first proposed last year.

That's what the lawsuit filed Wednesday is challenging. New Jersey and New York are co-leading the litigation in the U.S. District Court for the Southern District of New York. Connecticut, which created a similar charitable contribution scheme, is also a plaintiff.

New York Attorney General Letitia James, in a statement after the suit was filed, defended the state's efforts and called the federal government's actions unlawful.

“We will not stand idly by as this administration throws out decades of historic precedent putting our local economies, education systems, and other critical public programs at risk,” James said. “My office stands firm against this unlawful attack, and will do everything in our power to ensure that state taxpayers are protected.”

The lawsuit alleged that, in promulgating the rule, the IRS violated two major federal laws: the Administrative Procedure Act, commonly used by states that sue the federal government, and the Regulatory Flexibility Act.

On the first law, the suit argued that the agency's decision directly conflicted with a section of the Internal Revenue Code that, the states argued, simply allows deductions for charitable contributions in the statute's plain language. Congress hasn't taken action to change that law, so the agency's rule shouldn't stand, the complaint said.

“Had Congress wished to upend more than a century of precedent, it would have done so in clear terms,” the lawsuit said. “Congress has not done so, and the IRS cannot be permitted to arrogate congressional power.”

There are also more specific sections of the rule that violate the APA, the states argued. The rule requires taxpayers to subtract the value of SALT credits from their federal charitable contribution deduction, for example, but doesn't require them to subtract the value of federal, state and local deductions.

The rule violated the Regulatory Flexibility Act, the states argued, because the IRS failed to prepare an analysis on how it would impact local governments. That was required, the suit said, because the rule was expected to have a “significant economic impact” on governments in the three states.

The litigation was filed on the same day that a coalition of local governments in New York, led by the village of Scarsdale in Westchester County, filed their own suit on the same issue in the Southern District. Their claims were also brought under the APA.

Assemblywoman Amy Paulin, D-Westchester, helped craft the state law in New York that was intended to allow state and local taxes to be fully deductible as charitable contributions. She also criticized the decision from the IRS in a statement Wednesday morning.

“In trying to satisfy the whims of this administration without running afoul of powerful interests, the IRS regulations strayed far from the law that they were supposed to interpret,” Paulin said. “These regulations will cause real harm for villages like Scarsdale and taxpayers across the country struggling to remain in the communities they fell in love with and to send their children to the same nurturing, high-quality schools.”

New York is, separately, leading litigation against the Trump administration against the cap on state and local taxes, itself, arguing that the limit has unlawfully forced states to change their own tax code. That lawsuit is ongoing.

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