The Ethical Dilemma of Dependency with Newly Enacted Tax Benefits
Tax professionals face ethical dilemmas with each client they meet. In today’s blog we’re going to take you to a video scenario where the age-old question of dependency runs up…
March 7th, 2022
The question asking if an individual is a dependent or if they might file on their own as an independent taxpayer has always been an issue. In recent years this question has been made more complicated with the arrival of economic impact payments (EIPs) and recovery rebates which provide additional temptation to stretch dependency rules to claim more of these benefits. But does not claiming someone automatically make them an independent taxpayer? Also, how do we handle dependency with married couples who file separately, or divorced couples, or students in school who might provide some of their own support? What are the rules which guide who claims or doesn’t claim dependent(s)?
Tom O’Saben, EA
LINK REFERENCED IN VIDEO:
Hello again, everybody out there in tax preparation land. Welcome to this week’s video blog, where we’re going to talk about revisiting the age-old question of dependency. For those who don’t know me, my name is Tom O’Saben. I’m an enrolled agent. I’m the Assistant Director for Professional Education and Outreach for Tax School. I’m a full Tax School instructor and author and reviewer of the University of Illinois Federal Tax workbook. I do webinars, blogs, and it seems like I’m always involved in something with Tax School. In addition, I’m a tax practitioner just like you. And I’ve been at this for more than 30 years. So, these issues that we talked about are as timely for me as they are for you.
So, what we want to discuss today is a question that has really reared its head more frequently in recent years but has always been an issue. And kind of a difficult one to navigate takes a lot of a lot of work, a lot of calculations and such to determine whether a person is a dependent of another taxpayer. And why it’s become more of a discussion in these recent years, especially in tax years, 20 and 21, deal with the notion of these economic impact payments or recovery rebates, and how those can be claimed by persons who file their own returns. So sometimes dependents will not qualify for those payments. So, the question becomes to claim or not to claim. Is that really the question? And as I mentioned, there are incentives out there for taxpayers to file on their own. But the first premise to take away from this discussion is, does not claiming someone automatically make them independent? So, it would go to reason, and you would think that it would make sense that taxpayers who pass on a dependency exemption, or claiming a person as a dependent, we really don’t have dependency exemptions now during the TCJA years, does that make them able to file on their own and be independent? The answer is maybe not. So that’s those issues with maximizing federal benefits.
As we go through this discussion, the references for you to go to our IRS, pub 501, which is dependent standard deduction and filing information, and Internal Revenue Code section 152, which defines a dependent.
So, let’s start then with the basics. We need to talk about the test for if someone is a qualifying child. So first, there’s an age test. Well, a person can be any age if they happen to be permanently and totally disabled. Now, if they’re not, then they need to be under age 19 at the year end, and they need to be younger than you or your spouse. When we’re talking about you, we’re talking about the taxpayer. But then we get into the notion of those children who are students. Are they under age 24 at the end of the year, and a full-time student for at least five months of the year? And we still have that other test. Are they younger than you or your spouse if you file a joint return? So, we got some tests here for qualifying child, those aren’t the only tests.
Still in the area of a qualifying child, another test is residency. They have to have lived with you for more than half the year. And periods of temporary absence, such as being away at college, don’t count for the residency test, more tests coming. Probably the biggest one in dealing with a qualifying child and the one you have to address now and this notion of whether or not a child is going to file on their own deals with the support test. An interesting point in the qualifying child is that they, they the child, must not have provided more than half of their own support for the year, regardless of who did provide the support, and what support – food, fair rental value of home, clothing, transportation, etc. We got an example from the IRS publication which says that you. let’s make you the parent. provides $4,000 towards your 16-year-old son support for the year. He has a part time job and provided $6,000 to his own support. He provided more than half of support for the year. Therefore, he isn’t your qualifying child. So we can assume there that the support was $10,000 for the year, and you provided less than half. They provided more than half – the child provided more than half of their own support. More rules. If we’re dealing with the notion of what is support, I’ve got a hyperlink to help you with that in going to the irs.gov It’s probably the best place to go to determine support.
In addition, there’s a worksheet that you might want to go through. And you might probably want to keep this in your record, if you were to determine that, for example that 16-year-old is providing, or they’re not having someone else providing more than half their support, and therefore they could be independent might want to retain this in your work papers. And again, I gave you the hyperlink on the previous slide. To use this kind of worksheet. They’re also available other sources, you could pretty much Google them and find them, find them where you’re looking.
So, we have some guidance from the Internal Revenue Service, which says, what is gross income. You’ll notice that I’ve got a couple of terms highlighted here. It includes taxable unemployment compensation. Which you think back to tax your 2020 got a circumstance where we had part of unemployment excluded from income. So perhaps that wouldn’t be considered in the definition of gross income. We often get into a discussion about dependents or children who receive Social Security benefits. The IRS guidance says we’re talking about taxable Social Security benefits. So, if it isn’t taxable, it’s not included in the definition of gross income. If you want to test that, I challenge you to open up a dummy return in your software and put just some social security benefits in and you’ll see that there’s no taxable income. Social Security is only includable in income when there’s some other kind of income going into the formula of what gets included up to 85% of Social Security, to see that we have taxable benefits.
We also talked about that scholarships and fellowship grants can be part of gross income unless they’re used for school expenses. If they’re not used for school expenses, then they are going to be part of gross income. But if they’re not part of, I’m sorry, they’re not used for school expenses, then they will be part of gross income.
So we have more tests for qualifying child. We have a relationship test. How is that child related to you the taxpayer? Well, we say daughter, son, stepdaughter steps on foster child, sister, brother, etc, etc, or descendants, such as a niece or a nephew. So there is a familial relationship that is a test for a qualifying child.
We also have a joint return test is that qualifying child filing a joint return with someone else, which certainly indicates they’re married. Now, I will tell you, as I’m saying here on the slide, that if they don’t have a filing requirement to file a return, and they’re only filing in order to get a refund of withholding or estimated tax payments, then they don’t have a filing requirement. But however, if they file a tax return for other benefits, such as earned income credit, or education credits, or as we’ve been talking about these EIP or recovery, rebates, then there is a joint return required to be filed, and therefore they probably would not be a qualifying child again. Joint return, no, but yes, allowed if they’re only filing for a return of taxes that have been withheld, or estimated tax payments that they made.
So from our friends at TheTaxBook, I liked this carve out here, and I thank the folks of TheTaxBook for providing this, a qualifying child of more than one tax payer if we talk with taxpayer, we talk about a tiebreaker rule. First of all, we talk about parents. And this gets into the notion, and I think next week, John Richmann, one of our tax material specialists at Tax School, is going to talk about married filing jointly versus married filing separately. I think this is a very primary takeaway that you need to have from this week’s blog. If we talk about parents, first of all, who gets the tax benefit? Parents can choose as long as only one parent actually claims the child. So if they agree between themselves, it is not an income test. We really don’t have a tiebreaker if the parents agree. So I think that’s a really, really important takeaway. Married taxpayers, and we’ll see an example in a little bit driving that home. If we have a parent versus a non-parent, the parent is going to win. If we have a parent versus that nonparent, but no parent claims the child, non-parent, if the non-parents adjusted gross income is higher than any of the parents, that’s where the tiebreaker will go. If we’re going to have two non-parents wanting to claim someone as a qualifying child, then we’re going to have the taxpayer with the highest AGI. But the number one takeaway I want you to have here is parents can choose. There is no income test unless they can’t agree. Thanks again to the folks at TheTaxBook.
More information from TheTaxBook says where more than one parent claims a child -what happens here? We have special rules. If that qualifying child can be with two taxpayers, let’s see what happens. If two parents claim the same qualifying child, the tiebreaker goes to the parent with whom the child resided for the longest period of the year. They’re the custodial parent. We see that often in divorce arrangements. If the child resides with both parents and equal amount of time during the year, you might spend time going through the dependency and see who does the child spend the greater number of nights with – it’s very interesting. The tiebreaker then goes to the parent with the highest AGI. Remember, again, this isn’t a situation where the parents have a dispute as to who will claim the child. They haven’t agreed. We have more information provided from our folks at TheTaxBook.
Here’s an example. We have Nathan and Connie are married they have one child. They lived together all of 2021. In January of 2022, the couple separated. Nathan and Connie file separate returns for 2021. Since their trial, is a qualifying child for both,Nathan and Connie can choose which of them will claim their child as a dependent. Now, let me stop here for a moment. Forget about the point about that they separated. Let’s just say that Nathan Connie are married with one child. They were married all of 2021 They decided that maybe it’s beneficial to file separate returns. There isn’t a a dispute within their marriage. They’re just looking to see if would they benefit from filing separately? This is what you’re going to have the discussion with John next week. Look what it says Nathan and Connie can choose which of them will claim their child as a dependent. There is no AGI test there. But let’s look at example two and we’re in the same facts example one now, Nathan and Connie don’t agree. They file separate returns and they both claim the child. Now we have a dispute – you follow me? What happened here – we had Nathan’s AGI is illustrated at $70,000 and Connie’s at 75. Because we have more than one parent claiming the child and they cannot decide and we have equal residency, guess what tiebreaker is going to go to Connie because she has the higher AGI. My friends, this is the number one Number One Number one takeaway I want you to have from this circumstance. Again, if parents meet all of the rules to be a parent of a child, if they can agree there is no AGI default as to who claims the child. It’s only as we show an example to thanks again to the folks at TheTaxBook, where they don’t agree that the tiebreaker rears its head and says okay, if everything else is equal, then we’re going to highest AGI that’s an important takeaway from this week’s blog.
Alright, let’s move on to qualifying relative. We already talked about qualifying child. First, they need to not be a qualifying child. Well, let’s see if they’re under age 19. Okay, then they’re a qualifying child. So we’re talking about maybe who’s someone who’s 19 or over and not a full time student, or maybe they’re more than 24 years old. Here we introduce for the first time there’s an income test, we didn’t see an income test at all in qualifying child because there isn’t one, there is a support test, which says that they the qualifying child must not provide more than half of their own support. But here we run into an A qualifying relative, there comes the income test See $4,300 That I put here on the slide. Well, that’s an interesting number that you should recognize, in essence, that’s the personal exemption amount that during the TCJA years doesn’t appear on a tax return, but it sits back in the wings to help make some other types of determinations, this being one. And then thirdly, this is a differentiation of qualifying relative for qualifying child. The test on support for the qualifying child was that they must not provide more than half their support. Okay. For a qualifying relative it says you must provide more than half of their support. And again, by you, we are referring to the person that’s going to claim this individual. So, you’ve got that 39 year old person child living in your basement is not disabled. Living your clients’ basement. Isn’t working – spends all their time playing on the computer and watching old movies. What do we got? We may have a single parent who could qualify as head of household because they have a qualifying relative. Let’s think about that person. Thirty-nine years old, not disabled. So not going to be a qualifying child. So, let’s go to qualifying relative, are they earning less than $4,300 a year? Answer? Yes, Then is your client providing more than half of their support? And I think you know the answer there. Here you have a qualifying relative which more than anything, brings our client into the determination of perhaps being a head of household.
The IRS has an interactive tool that can help folks determine who you may claim as a dependent, I’ve given you the hyperlink right there to use. So, I think that’s going to be an interesting circumstance to consider. So as the Facebook Group posts has been, as the discussions have been in our webinars and everything, dependency is a really, really big issue to consider. But remember, a couple of takeaways. One, just not claiming a dependent does not make them independent. Also, I really didn’t give you any kind of an income test as to when someone can file on their own. Can we have a 17, 18, 19, 20-year-old student, perhaps qualified to file on their own? The question becomes, are they providing more than half of their support? Right? So the other takeaway being, let’s go back to that 39 year old living in mom’s basement, if that individual just happens to live with mom, maybe he wants to look out for her there, and he’s making $25,000? Well, for that qualifying relative, there is, in fact, an income test isn’t there? They’re not disabled, then we’ve got that $4,300 test. So again, takeaways that you have are that in a qualifying child situation, we’re not looking at income, we’re looking at support, and are they the dependent, providing more than half of their support? If they are, then they may, in fact, be independent. And that qualifying relative, we do have an income test. And that income test will drive whether that person is a qualifying relative.
So, I hope this kind of clarifies some of the consideration you’re having. And again, it’s going to kind of segue into the blog that John does next week to talk about married filing separately and where the dependents should be allocated. And as I said, as your number one takeaway from the session all the way back to, if parents can decide or agree, then the children can be placed for claiming purposes or credit purposes, with either parent. It is not driven by the income or the highest income of the two parties unless we run into that tiebreaker scenario.
Again, quick tidbits as I call them, quick as we’re running into almost 18 minutes in this presentation. you got a little more than a month to go. Hang in there. Go to the Facebook Group. There’s lots and lots of questions and help coming from your contemporaries. And for now, for all of us here at the University of Illinois Tax School. This is Tom O’Saben, saying goodbye for just a while.
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