Hamill: When the IRS acts like a house cat, taxpayers find room to play

When the cat’s away, the mice will play. This is said to originate from a 14th-century Latin phrase.

The saying seems to imply that if the cat is home, the mice will need to hide. That is, the mice’s actions are dictated by whether the cat is watching or not.

I am not a cat person. I have, and have had, dogs. But I have heard cat people say, “This one’s a mouser.”

That seems to imply that not all cats are mousers. The transitivity property would otherwise suggest that there is no need to call a specific cat a mouser.

That is, if cats keep mice in line, and Snowball is a cat, then Snowball will keep the mice in line.

But cat people say that feral cats are the best mousers. Many domestic cats prefer to bask in the sun by a window rather than get up and chase a mouse.

The IRS seems to have divisions of both feral and domestic agents. Taxpayers prefer to avoid the feral variety. No ability to play when they’re around.

In November 2020, the IRS issued a notice. A notice is what it says. It’s like posting something on a tree.

A notice lacks the authority of a regulation. There is no comment period and no need to consider substantive comments before final issuance.

Notice 2020-75 is often called the “SALT workaround.” It offers relief from the 2017 tax law rule that state and local taxes were limited to $10,000 of annual tax deductions.

The notice claims authority from a 1958 IRS ruling. That ruling said a partnership could deduct a city of Cincinnati earned income tax.

The Cincinnati tax was imposed on a partnership or a corporation if that entity earned the profit.

The tax was imposed on the individual if a proprietor earned the profit. The ruling held that an entity could deduct the payment for the tax imposed directly on the entity.

The 1958 ruling cited a 1954 IRS ruling that reached a similar conclusion for a tax imposed by the city of Louisville.

The purpose of the 2020 notice was to allow states to change their laws to allow the tax attributable to pass through entity income to be paid by the entity.

The notice then concluded that the entity could claim the deduction before passing the income through to the owner.

The owner could deduct the tax without regard to the $10,000 limit imposed by the 2017 law.

Feral tax practitioners noted several problems with the conclusions of the notice. It allowed the entity to avoid separately stating the tax deduction.

A separate accounting would have forced the owner to report the deduction as a tax, which would invoke the $10,000 limit.

It is hard to imagine why the Notice 2020-75 tax would not be separately stated. The “entity tax” of this notice is quite different than the 1954 and 1958 scenarios.

States allowing an entity to pay the tax did not really impose the tax on the owners. The tax payment was elective and was essentially a prepayment of the owner’s tax liability.

A feral IRS would not have allowed such gameplaying. But the 2020 notice was clearly written by the domesticated agents.

The notice continues to be useful even with the new $40,000 allowed tax deduction. But it still suffers from the same deficiencies in logic.

The notice itself says the IRS will issue regulations to replace the notice. The title begins “Forthcoming Regulations….”, making clear the notice is temporary.

The last section of the notice says that people can rely on the notice before regulations are issued, but only “as described in this section 4.”

Feral practitioners read section 4 as limiting the notice to payments made before Nov. 9, 2020. The regulations were supposed to cover later payments.

An earlier version of a workaround had people make charitable gifts to states adopting laws for an offsetting credit against the tax due on the owner’s tax return.

IRS regulations said that “charitable” gift did not create a deductible payment. The Second Circuit Court of Appeals just upheld the IRS regulations.

The $40,000 limit of the new big bill relaxes the need for some people to use the entity tax payment. Some will still need it.

But the whole foundation of the 2020 notice was built on a domesticated IRS. On this issue, the cat is not a mouser.