EIC Puzzle

[Koss]

The following three people live in one household all year. No one else lives in the home. All are US citizens. None are married. All other "normal" assumptions are valid. This is not a trick question.

Sarah is 40 years old. She is disabled. She has no income other than social security benefits. During 2007, she received $10,368 in social security benefits.

Megan is 18 years old. Megan is Sarah's daughter. Megan has wages of $13,000, and has no other income.

Crystal is 9 months old. Crystal is Megan's daughter. Crystal has no income.

Can Megan claim EIC with her daughter as a qualifying child?

Or does that violate the rule that says that you cannot claim EIC if you are the qualifying child of another taxpayer?

In other words, is Megan a qualifying child of Sarah, even though Sarah has no taxable income, no tax liability, and no filing requirement?

Here again, the IRS instructions for Form 1040, for 2007 ask:

Could you, or your spouse if filing a joint return, be a qualifying child of another person in 2007?

And if the answer is YES, then you cannot take the Earned Income Credit (page 45, general instructions for Form 1040).

But the text of IRC 32 says:

If an individual is the qualifying child of a taxpayer for any taxable year of such taxpayer beginning in a calendar year, such individual shall not be treated as an eligible individual for any taxable year of such individual beginning in such calendar year.

The term “qualifying child” means a qualifying child of the taxpayer (as defined in section 152 (c), determined without regard to paragraph (1)(D) thereof and section 152 (e)).

This is not the question that is addressed by IRS Notice 2008-5.

But it highlights the original problem, which is not limited to the dependent exemption, or to the rules that govern the definition of qualifying relative.

The rules as they are written appear to require the taxpayer to determine his or her eligibility for certain tax benefits by using information about another person, that may not be available. And even when the information is available, the rules raise complex, difficult questions about how the "qualifying child" relation is defined when the other person is not required to file a return, or is not eligible for any of the benefits associated with a qualifying child.

Note that the language of the IRC says that an individual is not eligible for EIC if that individual IS the qualifying child of a taxpayer for the year in question. But the question posed by the IRS is "could you be a qualifying child of another person?"

Which raises once again the question that I posed two years ago:

How can someone have a qualifying child if the person is not even eligible for any of the benefits associated with having a qualifying child?

At what point do we concede that Megan is not Sarah's qualifying child, because this is simply not what Congress intended, and it is not a reasonable interpretation of the law?

For example, what if Sarah died in late January 2007, after receiving one social security check? Does this change anything?

What about the "lived in your home for more than half the year" test? If Sarah died in January, doesn't that mean that Megan did not live in her home for more than half the year? I don't think so. The IRS instructions say that

A person is considered to have lived with you for all of 2007 if the person was born or died in 2007 and your home was this person's home for the entire time he or she was alive.

[General instructions for Form 1040 (2007), page 17]

Soooo... hmmm... does it matter whether it was Sarah's home or Megan's home?

I mean, in the fact pattern I described, is Megan living in Sarah's home or is Sarah living in Megan's home?

Does it make a difference which name is on the lease? Or who is actually paying the rent?

Probably not. The operative language in IRC 152(c) is "the same principal place of abode."

Gee, what if Sarah had no income at all? Now Sarah appears to be a qualifying person for Megan for purposes of Head of Household. Is anyone still going to argue that Megan is somehow Sarah's qualifying child, and that this precludes Megan from claiming EIC for her own child?

But Megan meets the definition of a qualifying child for Sarah for purposes of EIC. She meets the age, relationship, and residency tests, and the support test is not applicable to EIC. And according to a lot of people on this board, Sarah is a taxpayer even if she has absolutely no income at all.

Like I said in an earlier post, Congress needs to go back to the drawing board.

In the meantime, we have a responsibility to interpret the rules in a way that makes sense. And that's not going to get easier...

Burton M. Koss
koss@usakoss.net

[Koss]

Further rambling

The guts of the problem is this:

The prevailing interpretation of the rules often turns heavily, or even exclusively, on hypothetical, alternate realities. In the fact pattern I described above, I concede that Megan could be Sarah's qualifying child, for purposes of EIC, if Sarah had any earned income.

And Gerald Ford could have been an insurance executive.

And Atlanta could have been the capital of the USA, if the South had won the Civil War.

And if JFK had not been assassinated...

These rules desperately need to be clarified or rewritten, so that taxpayers, and the IRS when reviewing a return, can make determinations based on reality, and not on some parallel universe, or some other contingent fact pattern that doesn't actually exist.

The IRS appears to be attempting this, or at least taking baby steps, with Notice 2008-5...

BMK

[erchess]

Koss,

I don't think the pattern of facts you present is much of a mind bender. Megan is not Sarah's qualifying child because Megan has more income than Sarah. However, if Megan earned less at her job than Sarah got in disability payments, then you could argue that neither woman may claim EIC because Crystal and Megan would be qualifying children of Sarah and Sarah had no earned income.

[Koss]

Four Tests

I don't think the pattern of facts you present is much of a mind bender. Megan is not Sarah's qualifying child because Megan has more income than Sarah. However, if Megan earned less at her job than Sarah got in disability payments, then you could argue that neither woman may claim EIC because Crystal and Megan would be qualifying children of Sarah and Sarah had no earned income.

Below is the income test for determining if one person is the qualifying child of another:

.

The quote box is not a typo. There is no "income test" for determining whether you have a qualifying child. A four year old might have eleven million dollars of gross income, and he can still be the qualifying child of his mother--as long as he is not providing more than half of his own support.

But for purposes of EIC, the support test is not applicable.

Therefore, in the fact pattern I described, Megan appears to be Sarah's qualifying child.

Suppose Sarah had $1200 in wages. Do you still maintain that Megan is not Sarah's qualifying child for EIC?

Read the definition provided by the IRS on page 44 of the Instructions for Form 1040 (2007). Then read IRC 32, and tell me what you think.

Income has no bearing on EIC.

BMK

[Koss]

Not a tiebreaker

The tiebreaker rules are not applicable to determining whether Megan is Sarah's qualifying child. The tiebreaker rules are applicable only when:

(i) a child is the qualifying child of more than one taxpayer, and
(ii) more than one taxpayer actually claims the child.

Megan is not the qualifying child of more than one taxpayer.

Crystal is the qualifying child of both Megan and Sarah.

If Sarah has earned income, and both Megan and Sarah try to claim Crystal, then Sarah will win because she is the child's parent. The income level still doesn't matter.

BMK

[New York Enrolled Agent]

Burton

Part of the problem trying to follow this is that "qualifying child" has two different meanings.

I believe a qualifying child for purposes of §32 is a subset of a qualifying child of §152. Perhaps, it's me but I'm having trouble following all the qualifying children.
Might be useful if you could differentiate somehow

[Koss]

Superset

Burton

Part of the problem trying to follow this is that "qualifying child" has two different meanings.

I believe a qualifying child for purposes of §32 is a subset of a qualifying child of §152. Perhaps, it's me but I'm having trouble following all the qualifying children.
Might be useful if you could differentiate somehow

The term subset is applicable, but you are expressing the relation backwards.

To have a QC for dependency purposes, the child has to meet four tests. To have a QC for EIC purposes, the child only has to meet three of those four tests.

So any child that is a QC for dependency is automatically a QC for EIC. But the converse is not true. There are some children who are QCs for EIC but not for dependency, because they fail the support test.

By way of analogy: All revenue agents are federal employees, but not all federal employees are revenue agents...

For any given taxpayer, the set of all his qualifying children for purposes of dependency includes all his qualifying children for purposes of EIC. But the set of all his qualifying children for EIC does not necessarily include all his qualifying children for dependency.

QCs as defined in IRC 152 are a subset of QCs as defined in IRC 32.

There are some QCs that meet the criteria in IRC 32, but do not meet the criteria in IRC 152. So the set of QCs for purposes of EIC is larger than the set of QCs for dependency.

I don't know if you really intended to invoke all the baggage of set theory and formal logic with your original post. But it's actually an excellent framework for analyzing these issues.

This is the point in a logic class where the professor starts drawing circle inside circles...

So each taxpayer has five different sets of QCs:

(i) a set of QCs for dependency
(ii) a set of QCs for the Child Tax Credit
(iii) a set of QCs for Head of Household
(iv) a set of QCs for Child Care Credit
(v) a set of QCs for Earned Income Credit

Some of these sets "overlap," and one may be a subset of the other, as you pointed out. But it is still helpful to distinguish between them, because the criteria are different for each.

My argument is:

If each set is defined as a relation between the taxpayer and the group of children that satisfy certain criteria with respect to the taxpayer and the specified tax benefit...

then...

if the taxpayer cannot claim the specified benefit because he does not meet certain conditions precedent, such as paying more than half the cost of keeping up the home, or actually paying for child care, or not being a dependent himself...

then I don't think the set can even exist. If Tom cannot have any dependents at all, because he is a dependent of someone else, then the set of all children that are that are Tom's qualifying children for purposes of the dependent exemption is the empty set.

BMK

[Koss]

The Sixth Set

I have argued that for any particular individual, there are five different sets of qualfiying children: one for each of the five code sections in question.

Some believe there is a sixth set, or that there is really only one set: The set of children that meet the four tests with respect to the individual, without regard to whether the individual is eligible for any of the benefits of the five code sections. I don't think this set exists, because it is not defined anywhere in the tax code. The tax code does not define qualifying child except in the context of the five tax benefits. For me, therefore, the term qualifying child is meaningless unless you first specify which of the five code sections is applicable.

And if the taxpayer is precluded from claiming the benefit of the applicable code section, because he fails to meet some other eligibility criteria, such that he cannot claim that benefit even with a qualifying child, then the question of whether he has any qualifying children for purposes of that code section becomes irrelevant. You can't have a qualifying child, say, for purposes of Head of Household, if you didn't pay more than half the cost of keeping up the home.

We have to look at what the taxpayer is eligible for before trying to determine whether the taxpayer has any qualifying children.

This analysis is not entirely consistent with the IRS position in Notice 2008-5. But I still think it is the best shot at finding a coherent interpretation of the law for all five code sections. Notice 2008-5 really only deals with the dependent exemption, and only addresses a rather narrow issue involving the definition of a qualifying relative.

BMK