New York's attorney general announced on Thursday she was suing the Trump Foundation, as well as Donald Trump and his children, alleging "extensive and persistent" lawbreaking.
Barbara Underwood said the charitable foundation had engaged in "unlawful political coordination" designed to influence the 2016 election.
The lawsuit seeks to dissolve the foundation, Ms Underwood said, as per BBC report.
The foundation attacked the suit, calling it "politics at its very worst".
In a statement, Ms Underwood said Mr Trump had illegally instructed his foundation to provide support to his presidential campaign by using the foundation's name and funds it raised to promote the campaign.
The president hit back at the lawsuit on Twitter, saying that "sleazy New York democrats" were "doing everything they can to sue me". He vowed he would not settle the case.
The lawsuit alleges that the foundation paid $100,000 to settle legal claims against Mr Trump's Mar-A-Lago resort, $158,000 to settle claims against one of his golf clubs, and $10,000 to purchase a painting of Mr Trump to hang at another of his golf clubs.
The purchase of the painting was an example of one of "at least five self-dealing transactions", the statement said, which violate tax regulations on non-profit charities.
"As our investigation reveals, the Trump Foundation was little more than a checkbook for payments from Mr Trump or his businesses to nonprofits, regardless of their purpose of legality," Ms Underwood said. "This is not how private foundations should function."
The Trump Foundation issued a statement denied the charges and accusing the attorney general of holding its $1.7 million in remaining funds "hostage for political gain".
New York is also seeking $2.8 million of restitution, a 10-year ban on Mr Trump serving as a director of a New York non-profit, and similar one-year bans for his children Donald Jr, Eric, and Ivanka, who serve on the foundation's board.
Eric Trump distanced himself from his own charitable foundation after the election, the New York Times reported, after it came under investigation by the attorney general for allegedly shifting its resources to the Trump Organisation.
The Trump foundation lawsuit adds to Mr Trump's mounting legal challenges, which include a wide-ranging special counsel investigation into alleged ties between the Trump campaign and Russia. Special Counsel Robert Mueller has indicted several of Mr Trump's associates and raided the home and office of the president's long-time lawyer and fixer, Michael Cohen.
