This is the time of year that I normally crawl out from under a rock, and find time to participate in the message boards...
So I might as well open a discussion of IRS Notice 2008-5, which provides formal guidance on UDC. Someone else posted a link to it on 12/18, but only got one reply.
IRS Notice 2008-5 makes it crystal clear that when you have an unmarried couple, and the child is hers but not his, and they lived together for the entire year, and he supported the child, and she has no income, that he can claim a dependent exemption for the child under the rules for qualifying relative.
Over the last two years, this scenario, along with several others, has been extensively debated. To my knowledge, the IRS has not issued any guidance on the matter until now. But the overwhelming consensus in the tax professional community was that the guy could NOT claim the child as a qualifying relative, because IRC 152(d)(1)(D) says you can't claim someone as a qualifying relative if the person is the qualifying child of another taxpayer. Most professionals concluded that the child was the qualifying child of his mother, even if she had no income and no tax liability.
UDC first took effect for 2005 returns. In January 2006, Doug Lee and I posted an article on another website, in which we argued that the prevailing interpretation of UDC was simply ridiculous, and could not possibly reflect the congressional intent. We pointed out that on this reading of the law, two young siblings who live with and are supported by their second cousin would be considered qualifying children OF EACH OTHER, and that this would mean that their cousin could not claim either one of them as a qualifying relative. We then pointed out that any reading of the law that would allow the cousin to claim the two siblings as qualifying relatives would also allow the guy to claim his girlfriend's kid.
For a few weeks, this scenario had some people wringing their hands or shaking their heads. But most who chose to participate in the discussion defended this interpretation, claiming that the meaning was clear: if the child meets the age, relationship, residency and support tests for ANYONE, then the child is that person's qualifying child, and no one can claim the child as a qualifying relative--even if this means that a six year old is the qualifying child of a nine year old with no income.
People found various ways to rationalize this interpretation. Some dismissed the example of the siblings as far-fetched and too hypothetical, arguing that in the real world, the adult cousin supporting them would have guardianship, and that this would make each one his qualifying child, through "placement by an agency." But this ignored the fact that everyone agreed that if the cousin was supporting and living with only ONE of the two siblings, even without legal guardianship, then that child would be his qualifying relative, and that the mere presence of the child's brother in the same household was somehow held to disqualify the cousin from claiming either one of them as dependents.
Many in the professional community appeared to rationalize this goofy idea by focusing on the unmarried couple, and arguing that Congress intended to yank the qualifying relative exemption from the guy who is supporting the woman and her child, in an effort to discourage this type of "shacking up," and to discourage unwed motherhood.
I am not suggesting that every tax professional is an extreme right-wing evangelical republican who wants to turn this country into a theocracy. Rather, I am suggesting that somehow, an awful lot of tax pros, whether they agreed with it or not, convinced themselves that the UDC legislation was based on this kind of ideology. Viewed through this warped socio-political lens, an utterly absurd reading of the law began to seem plausible.
At one point the debate turned on the meaning of "any other taxpayer." When I suggested that someone who had absolutely no income might not be a taxpayer in this context, some readers claimed that "everyone is a taxpayer," and implied that I was advancing a frivolous, tax-protester-flavored argument.
The IRS interpretation actually turns on this very question, i.e., whether the nonworking, unmarried mother of the child is considered a taxpayer within the meaning of IRC 152(d)(1)(D).
The core of the argument advanced in the article that Doug and I posted two years ago was that a person cannot have a qualifying child if they are not even eligible to claim any of the benefits associated with having a qualifying child.
The IRS guidance supports this position, and, remarkably, goes even further. If the child's mother worked, but earned only $2500, she IS eligible to claim EIC for her child. But it is also true that she is not required to file a tax return, because her income is below the filing threshold. In this case, the IRS notice indicates that the child is not considered her qualifying child if she chooses not to file a return, or if she files a return only to claim a refund of tax withheld (without claiming EIC). Therefore, in this particular scenario, it appears that the unmarried couple has a choice: Either she can claim EIC, or he can claim the dependent exemption.
Congress has not changed the law, and the IRS notice does not reflect a change in its interpretation of the law. It is a CLARIFICATION, and it is applicable to all tax years after 2004. This means that clients who were told, based on this widespread misinterpretation, that they could not claim an unrelated person may be able to file an amended return to claim the dependent exemption.
Some will be quick to blame Congress for creating this mess by writing such an ambiguous law, and others will blame the IRS Office of Chief Counsel for not clearing up the confusion earlier.
But the tax professional community bears some responsibility for what has happened here. Most tax professionals either ignored the issue because it didn't affect any of their clients, or allowed their thinking and analysis of the issue to become clouded by arguments that were deeply flawed.
If Congress passed a law which was somehow interpreted to authorize high school students to carry concealed handguns while in class, presumably to defend themselves in the event of a Columbine-style attack, the uproar over such a law would probably force the government to explain the law or change it. And it wouldn't take two years for that to happen. The generally accepted meaning of UDC was not quite as bizarre as concealed handguns for high school students, but it was pretty darn close.
Some tax pros, including Doug and myself, participated in various efforts to seek clarification of the law.
Perhaps, as a community, we did not make enough noise. But we certainly tried. The president of the NAEA sent a letter to the IRS commissioner. Articles written by tax attorneys appeared in professional journals, and the subject was addressed by National Taxpayer Advocate Nina Olson. Unfortunately, Olson appears to have accepted the now discredited interpretation. That being said, Olson helped bring the problem to the attention of Congress and the IRS.
The IRS did not respond in a meaningful way (until now), and Congress and its committees, to the extent that they reacted, wrung their hands and debated the issue in much the same way that we did. Somehow it does not surprise me that some Congressional staff members who commented publicly on the matter did not seem to grasp the depth of the problem. Perhaps Congress didn't really see it as a problem, because, as the IRS has observed in its notice, the conference report indicates that the intent of the law was to preserve, as a safe harbor, most of the original structure of the old law for claiming unrelated dependents.
When the law is ambiguous, and open to multiple interpretations, and there is no guidance forthcoming from the IRS, and the matter has not been addressed by the courts, the taxpayer has the right to file a return that is based on the interpretation that is most favorable to the taxpayer.
And tax pros have a professional responsibility to make clients aware of situations that are open to more than one interpretation, and to allow the client to choose which interpretation to use. It is here, I think, that to some degree the tax professional community has failed during the last two years.
I prepared returns in which I allowed the guy to claim his girlfriend's kid as a dependent. I did this only after I fully explained to the client that this was a gray area of the law, and that some tax pros disagreed with my interpretation. I also made sure the client understood their options if the IRS challenged the return, and I explained the possible consequences of having to pay back part of the refund, with interest and penalties.
In January 2006, Doug Lee and I wrote:
"We do not believe that this is how Congress wanted the rules interpreted, and in the scenario just described, we consider it unlikely that the IRS would adopt this position...
[T]he prevailing interpretation of UDC is not merely counterintuitive, inequitable, or bizarre. It is logically unsound. It is so flawed that it is unlikely to survive even a single tax year. Even if we are wrong, and the commonly accepted interpretation of UDC is an accurate reflection of the new law, the paradoxes and other unintended consequences that follow from it are so disturbing that we believe the law will be retroactively changed or clarified."
Our original article, which is only three pages long, is available at the following link:
IRS Notice 2008-5, which is five pages long, is available here:
Yes...
This post is the most diplomatic way I could find to say, "we told you so."
Burton M. Koss
koss@usakoss.net
So I might as well open a discussion of IRS Notice 2008-5, which provides formal guidance on UDC. Someone else posted a link to it on 12/18, but only got one reply.
IRS Notice 2008-5 makes it crystal clear that when you have an unmarried couple, and the child is hers but not his, and they lived together for the entire year, and he supported the child, and she has no income, that he can claim a dependent exemption for the child under the rules for qualifying relative.
Over the last two years, this scenario, along with several others, has been extensively debated. To my knowledge, the IRS has not issued any guidance on the matter until now. But the overwhelming consensus in the tax professional community was that the guy could NOT claim the child as a qualifying relative, because IRC 152(d)(1)(D) says you can't claim someone as a qualifying relative if the person is the qualifying child of another taxpayer. Most professionals concluded that the child was the qualifying child of his mother, even if she had no income and no tax liability.
UDC first took effect for 2005 returns. In January 2006, Doug Lee and I posted an article on another website, in which we argued that the prevailing interpretation of UDC was simply ridiculous, and could not possibly reflect the congressional intent. We pointed out that on this reading of the law, two young siblings who live with and are supported by their second cousin would be considered qualifying children OF EACH OTHER, and that this would mean that their cousin could not claim either one of them as a qualifying relative. We then pointed out that any reading of the law that would allow the cousin to claim the two siblings as qualifying relatives would also allow the guy to claim his girlfriend's kid.
For a few weeks, this scenario had some people wringing their hands or shaking their heads. But most who chose to participate in the discussion defended this interpretation, claiming that the meaning was clear: if the child meets the age, relationship, residency and support tests for ANYONE, then the child is that person's qualifying child, and no one can claim the child as a qualifying relative--even if this means that a six year old is the qualifying child of a nine year old with no income.
People found various ways to rationalize this interpretation. Some dismissed the example of the siblings as far-fetched and too hypothetical, arguing that in the real world, the adult cousin supporting them would have guardianship, and that this would make each one his qualifying child, through "placement by an agency." But this ignored the fact that everyone agreed that if the cousin was supporting and living with only ONE of the two siblings, even without legal guardianship, then that child would be his qualifying relative, and that the mere presence of the child's brother in the same household was somehow held to disqualify the cousin from claiming either one of them as dependents.
Many in the professional community appeared to rationalize this goofy idea by focusing on the unmarried couple, and arguing that Congress intended to yank the qualifying relative exemption from the guy who is supporting the woman and her child, in an effort to discourage this type of "shacking up," and to discourage unwed motherhood.
I am not suggesting that every tax professional is an extreme right-wing evangelical republican who wants to turn this country into a theocracy. Rather, I am suggesting that somehow, an awful lot of tax pros, whether they agreed with it or not, convinced themselves that the UDC legislation was based on this kind of ideology. Viewed through this warped socio-political lens, an utterly absurd reading of the law began to seem plausible.
At one point the debate turned on the meaning of "any other taxpayer." When I suggested that someone who had absolutely no income might not be a taxpayer in this context, some readers claimed that "everyone is a taxpayer," and implied that I was advancing a frivolous, tax-protester-flavored argument.
The IRS interpretation actually turns on this very question, i.e., whether the nonworking, unmarried mother of the child is considered a taxpayer within the meaning of IRC 152(d)(1)(D).
The core of the argument advanced in the article that Doug and I posted two years ago was that a person cannot have a qualifying child if they are not even eligible to claim any of the benefits associated with having a qualifying child.
The IRS guidance supports this position, and, remarkably, goes even further. If the child's mother worked, but earned only $2500, she IS eligible to claim EIC for her child. But it is also true that she is not required to file a tax return, because her income is below the filing threshold. In this case, the IRS notice indicates that the child is not considered her qualifying child if she chooses not to file a return, or if she files a return only to claim a refund of tax withheld (without claiming EIC). Therefore, in this particular scenario, it appears that the unmarried couple has a choice: Either she can claim EIC, or he can claim the dependent exemption.
Congress has not changed the law, and the IRS notice does not reflect a change in its interpretation of the law. It is a CLARIFICATION, and it is applicable to all tax years after 2004. This means that clients who were told, based on this widespread misinterpretation, that they could not claim an unrelated person may be able to file an amended return to claim the dependent exemption.
Some will be quick to blame Congress for creating this mess by writing such an ambiguous law, and others will blame the IRS Office of Chief Counsel for not clearing up the confusion earlier.
But the tax professional community bears some responsibility for what has happened here. Most tax professionals either ignored the issue because it didn't affect any of their clients, or allowed their thinking and analysis of the issue to become clouded by arguments that were deeply flawed.
If Congress passed a law which was somehow interpreted to authorize high school students to carry concealed handguns while in class, presumably to defend themselves in the event of a Columbine-style attack, the uproar over such a law would probably force the government to explain the law or change it. And it wouldn't take two years for that to happen. The generally accepted meaning of UDC was not quite as bizarre as concealed handguns for high school students, but it was pretty darn close.
Some tax pros, including Doug and myself, participated in various efforts to seek clarification of the law.
Perhaps, as a community, we did not make enough noise. But we certainly tried. The president of the NAEA sent a letter to the IRS commissioner. Articles written by tax attorneys appeared in professional journals, and the subject was addressed by National Taxpayer Advocate Nina Olson. Unfortunately, Olson appears to have accepted the now discredited interpretation. That being said, Olson helped bring the problem to the attention of Congress and the IRS.
The IRS did not respond in a meaningful way (until now), and Congress and its committees, to the extent that they reacted, wrung their hands and debated the issue in much the same way that we did. Somehow it does not surprise me that some Congressional staff members who commented publicly on the matter did not seem to grasp the depth of the problem. Perhaps Congress didn't really see it as a problem, because, as the IRS has observed in its notice, the conference report indicates that the intent of the law was to preserve, as a safe harbor, most of the original structure of the old law for claiming unrelated dependents.
When the law is ambiguous, and open to multiple interpretations, and there is no guidance forthcoming from the IRS, and the matter has not been addressed by the courts, the taxpayer has the right to file a return that is based on the interpretation that is most favorable to the taxpayer.
And tax pros have a professional responsibility to make clients aware of situations that are open to more than one interpretation, and to allow the client to choose which interpretation to use. It is here, I think, that to some degree the tax professional community has failed during the last two years.
I prepared returns in which I allowed the guy to claim his girlfriend's kid as a dependent. I did this only after I fully explained to the client that this was a gray area of the law, and that some tax pros disagreed with my interpretation. I also made sure the client understood their options if the IRS challenged the return, and I explained the possible consequences of having to pay back part of the refund, with interest and penalties.
In January 2006, Doug Lee and I wrote:
"We do not believe that this is how Congress wanted the rules interpreted, and in the scenario just described, we consider it unlikely that the IRS would adopt this position...
[T]he prevailing interpretation of UDC is not merely counterintuitive, inequitable, or bizarre. It is logically unsound. It is so flawed that it is unlikely to survive even a single tax year. Even if we are wrong, and the commonly accepted interpretation of UDC is an accurate reflection of the new law, the paradoxes and other unintended consequences that follow from it are so disturbing that we believe the law will be retroactively changed or clarified."
Our original article, which is only three pages long, is available at the following link:
IRS Notice 2008-5, which is five pages long, is available here:
Yes...
This post is the most diplomatic way I could find to say, "we told you so."
Burton M. Koss
koss@usakoss.net
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