Kiddie Tax 2008 Question

[dtlee]

I am wondering about the new rules for 2008. In the new rules, some much older children are now subject to the Kiddie Tax. In choosing which parent to use, one such rule is to use the custodial parent in a divorce situation. Generally, this should be the custodial parent under § 152(e).

While looking for something else, I found TC Memo 2007-324 which states the following:

Petitioner also does not qualify for the deduction under the special support test for children of divorced parents. Sec. 152(e)(1). Section 152(e)(1) applies only when the child is in the custody of one or both parents for more than one-half of the calendar year. We have held that once a child reaches the age of majority under State law, she is no longer in the custody of either parent for purposes of section 152(e). Ferguson v. Commissioner, T.C. Memo. 1994-114 [1994 RIA TC Memo ¶94,114]; Kaechele v. Commissioner, T.C. Memo. 1992-457 [1992 RIA TC Memo ¶92,457]. Petitioner's daughter was a resident of Virginia in 2003, and under Virginia law an individual reaches the age of majority when she becomes 18 years of age. Va. Code Ann. sec. 1-204 (2005). Petitioner's daughter became 18 years of age in March 2003, and therefore could not be in the custody of either parent for more than one-half of the calendar year

The relevance here is that they are saying that based on local law, once the child has reached majority age, the concept of custody disappears. Am I interpreting this correctly to mean that mean that for the new, older children covered by the Kiddie Tax in 2008 who are children of divorced spouses and who have reached the age of majority under local law, we must use the ex spouse with the higher income regardless of with whom they are living?

[Koss]

Which parent?

The rule requiring the child's income to be taxed at the rate of the parent with the higher income is applicable only to married couples who choose to file separate returns. It does not appear to be applicable to parents who are divorced, married but living apart, or never married.

Pub. 17 does tell the reader to use the income of the parent with the higher AGI if the parents are not married and living together. But that particular scenario is not addressed in the code.

Setting aside that particular anomaly, and returning to the original question, I agree that the code section that requires use of the income tax rates of the "custodial parent" could arguably be inapplicable in the case of divorced parents with a child who has reached the age of majority. But if it that code section is indeed inapplicable because neither parent has custody, it does not follow that the "parent with the higher income" criteria would become applicable by some sort of default operation.

Here's the original text of the code, when the rule was only for children under age 14:

(5) Special rules for determining parent to whom subsection applies
For purposes of this subsection, the parent whose taxable income shall be taken into account shall be—
(A) in the case of parents who are not married (within the meaning of section 7703), the custodial parent (within the meaning of section 152(e)) of the child, and
(B) in the case of married individuals filing separately, the individual with the greater taxable income.

Congress does not appear to have changed this text in any way; the new law amends the scope of children to whom the rules apply, but there has been no change to the process for determining which parent's income is used...

So... a couple different things could happen. Congress may fix this before we have to start preparing 2008 tax returns. I'm not holding my breath, 'cause it's been two years since WFTRA was passed, and we still can't make sense out of UDC. But if Congress fixes it, it could go either way. Maybe the parent with the higher income, or maybe just the parent with whom the child was living for the greater part of the year.

Or the parent that claims the dependent exemption. That would make the most sense.

Or... the IRS may just continue to interpret the meaning and intent of "custodial parent," in the context of this law, as that parent with whom the child lived for the greater part of the year...

Or maybe we should just disregard the law, and not figure the kiddie tax on the parent's income unless Congress rewrites it. If there is no custodial parent, then that section of the law becomes impossible to interpret. It's division by zero. And as I said earlier, I don't think it automatically defaults to the parent with the higher income just because the original rule no longer has meaning.

More thoughts coming...

Burton

[dtlee]

Or the parent that claims the dependent exemption. That would make the most sense.

This only makes sense if the "kiddie" is a dependent. In a situation where a large amount of money comes from unearned income (e.g., the child sells stock received at birth to help fund college) and uses these proceeds to pay for school expenses not covered by scholarship money, the student may indeed not be a dependent of either parent.

[dtlee]

Or maybe we should just disregard the law, and not figure the kiddie tax on the parent's income unless Congress rewrites it. If there is no custodial parent, then that section of the law becomes impossible to interpret. It's division by zero. And as I said earlier, I don't think it automatically defaults to the parent with the higher income just because the original rule no longer has meaning.

I like this idea. Of course we probably use form 8275-R to tell them that we are disregarding it.

Is it just me thinking this or is there a recent trend of them taking anything that is remotely straightforward in the code and making it unfathomable?

[Bees Knees]

You can't apply the logic of the Tax Court Case to the new law because it applied to a tax year prior to the new law.

Never assume tax principals can carry over after a tax law change.

[dtlee]

You can't apply the logic of the Tax Court Case to the new law because it applied to a tax year prior to the new law.

Never assume tax principals can carry over after a tax law change.

Bees,

Thanks for your input.

Assuming I accept your position (and I am not sure yet that I do since nothing changed in 152(e) that I am aware of), what would you proposee the rules are for defining the custodial parent is of a 23 year old "child" attending college and living on unearned income away from their divorced parents and with little or no contact with either of them?

[tpert]

You can't apply the logic of the Tax Court Case to the new law because it applied to a tax year prior to the new law.

Never assume tax principals can carry over after a tax law change.

Does this mean any time they change the tax law in any way, all of the tax court cases that applied to any code sections which are referred to by the new law are in some way invalid?

[Koss]

New laws and TC decisions

Does this mean any time they change the tax law in any way, all of the tax court cases that applied to any code sections which are referred to by the new law are in some way invalid?

It certainly does not mean that.

Sometimes a new law will effectively override a court decision, or make the decision irrelevant or inapplicable to certain circumstances. In fact, in some noteworthy cases, Congress has passed a new law precisely because the courts interpreted an earlier law in a way that Congress felt was inappropriate, unintended, or obsolete. The best example involves the home office of a surgeon. The case is known as Soliman.

With respect to the issue at hand, I disagree with Bees Knees. And Bees has not responded to Doug's last question. The question is, under the Kiddie Tax rules that go into effect in 2008, how do you determine which parent's income is used to tax the child's income, when the child is 23 years old, and living in his own apartment, at graduate school, 800 miles away from either parent?

The rules say to use the income of the parent who had custody of the child for the greater part of the year. But what is custody when the child is 23 years old??

The rules do not say:

"If custody is rendered meaningless because the "child" is an adult, then use the income of the parent with the higher AGI."

The rules say to use the income of the custodial parent if the parents are not married, and to use the higher income if the parents are married but file separately.

Congress passed a "new law" only in the sense that it amended one section of the code, to raise the age at which the kiddie tax is applicable. Congress did not amend that part of the law that addresses how you determine which parent's income is used to calculate the tax. So in that regard Congress has not changed the law. That part of the law simply refers to Section 152(e).

The problem here is this:

Because Congress has raised the age limit for the Kiddie Tax to an age that includes adults, that section of the code that is incorporated by reference to determine which parent's income is used no longer provides a valid criteria for selection. The courts have ruled that 152(e) is not applicable when the "child" in question has reached the age of majority. Therefore, the code section that authorizes the Kiddie Tax is using a criteria that is simply not applicable.

To me, it's a no-brainer. This is an oversight by the authors of the bill, or more likely a case of plain sloppiness or incompetence by the researchers and aides who work on the details of the bill before it is actually introduced by a senator or representative.

How could they have decided to raise the age limit without looking at the question of which parent, and how you determine which parent? And how could they have just blown through those rules without stopping to ask:

"Gee, what the heck does custody mean when the kid is 23 years old?"

BMK

[tpert]

Koss,

Thanks for the reply.

With respect to the issue at hand, I disagree with Bees Knees. And Bees has not responded to Doug's last question. The question is, under the Kiddie Tax rules that go into effect in 2008, how do you determine which parent's income is used to tax the child's income, when the child is 23 years old, and living in his own apartment, at graduate school, 800 miles away from either parent?

Not that I am an expert here, but I tend to agree with you and Doug. If we can't rely on prior interpretations of the other sections referred to by the law change, then neither can Congress. How would they have any chance of knowing what they were writing if they could not rely on the prior interpretations of the unchanged sections of the Code to remain intact.