Divorced Parents And A Dependent Child

 It is one of my least favorite issues in tax practice.

Who is entitled to a dependent?

Granted, there is no longer a dependency exemption available, but there are other tax items, such as the child tax credit, that require a dependent.

The issue can go off-the-rails if the parents are (a) divorced and (b) combative.

It occurs when both parents claim the same child for the same year.

One of the parents is going to lose the dependency, of course, but how the Code determines which one may surprise you.

The Code wants to know which is the custodial parent – that is, which parent did the child live with for the majority of the year. Granted, in some cases the answer may be razor close, but most of the time there is a clear answer.

The Code anticipates that the custodial parent will claim the child.

What if the noncustodial parent provides most of the child’s support?

The Code (for the most part) does not care.

How does the noncustodial parent get to claim the child?

If the parents get along, then there is no issue. Everyone follows the rules and there is no tax controversy.

If the parents do not get along and both claim the same child, the IRS is going to get involved. It will want to know: who is the custodial parent?

But the divorce decree says ….

You might be surprised how little the IRS cares about that divorce decree.

What it is interested in is whether a certain form was filed with the noncustodial parent’s return: Form 8332.

This form has to be signed by the custodial parent. If the parents do not get along, you can see the problem.

What happens if the noncustodial parent does not attach this form and both parents claim the child?

Let’s take a look at the DeMar case.

The divorce decree said that Mr Demar (Dad) was to claim the son in odd-numbered years. Dad claimed the son for 2015.

Mrs DeMar (Mom) also claimed the son.

The IRS came in. There (of course) was no Form 8332. The IRS could care less what that divorce decree had to say, so off to Tax Court they went.

Dad is going to lose this all day every day, except ….

Would you believe that – before the Tax Court hearing – Mom signed Form 8332?  

That doesn’t happen much.

There is a proposed Regulation on this point:

A noncustodial parent may submit a copy of the written declaration to the IRS during an examination to substantiate a claim to a dependency exemption for the child.

Did that save Dad?

Let’s keep reading:

A copy of a written declaration attached to an amended return, or provided during an examination, will not meet the requirement of this paragraph … if the custodial parent … has not filed an amended return to remove that claim to a dependency exemption for the child.

So one can file the 8832 late but one also has to prove that the other parent amended his/her return to remove the dependency for the child.

Guess what?

Mom did not amend her return.

Dad lost.

The IRS did not care about that divorce decree and the odd-numbered year.

I get it. The IRS has no intention of playing family court, so it established mechanical rules for the dependency. The average person focuses on the divorce decree – understandably – but the IRS does not.  Procedure is everything in this area.

Our case this time was DeMar v Commissioner T.C. Memo 2019-91.

A Failed E-Filed Return Hit With Penalties

 

I have noticed something about electronic filing of tax returns, especially state returns: there is a noticeable creep to demanding more and more information. I can understand if we are discussing tax-significant information, but too often the matter is irrelevant. We received a bounce from Wisconsin, for example, simply because there was a descriptor deep in the state return without an accompanying number.

How did this happen? Perhaps there was a number last year but not one this year. Could an accountant have scrubbed it out? Yes, in the same way that I could have played in the NFL. Work on a return of several hundred pages, add a few states in there for amusement, tighten the screws by closing in on a 15^th deadline and you might miss a description on a line having no effect on the accuracy of the return.

Why is this an issue?

Because if a state – say Wisconsin - bounces a return, then it is the same as never having filed a return. The penalties for not filing a return are more severe than – for example - filing a return but not paying the tax. Does it strike you as a bit absurd for a state to argue that one never filed a return when an accountant prepared (and charged one for) that state return?

The US Tax Court has reviewed the issue of what counts as a federal tax return in a famous case called Beard v Commissioner. The Court looks at four items, each of which has to be met:

·      It must purport to be a return;

·      It must be signed under penalty of perjury;

·      It must contain sufficient information to allow the calculation of the tax; and

·      It must be an honest and reasonable attempt to satisfy the requirements of the tax law.

Let’s look at a case involving the Beard test.

John Spottiswood (let’s call him Mr S) filed a joint 2012 tax return using TurboTax. He made a mistake when entering a dependent’s social security number. He submitted the electronic return through TurboTax on or around April 12. Within a short period, TurboTax sent him an e-mail that the IRS had rejected the return.

Problem: The e-mail was sitting in TurboTax. Mr S needed to log back in to TurboTax to see the e-mail. A professional would know to check, but an ordinary individual might not think of it.

Another Problem: Mr S owed almost $400 grand with the return. Since the return was never accepted, the bank transfer never happened. He did not pay the tax until almost 2 years later.

The IRS tagged him over $40 grand for late payment of tax.

I have no issue with this. Think of the $40 grand as interest.

The IRS also tagged him over $89 grand for late filing of the return.

I have an issue here. Mr S did try to file; the IRS rejected his return. I see a significant difference between someone trying and failing to file a return and someone who simply blew off the responsibility to file. It strikes me as profoundly unfair to equate the two.

Mr S protested the late filing penalty.

He had two arguments:

(1)  He did file (per the Beard standard).

(2)  Failing that, he had reasonable cause to abate the penalty.

I like the first argument. I would advise Mr S to provide a copy of the return to the Court and request Beard.

COMMENT: I suppose the issue is whether the return would meet the third test – sufficient information to calculate the tax. I would argue that it would, as the IRS could deny the dependency exemption and recalculate the tax accordingly. If Mr S objected to the loss of the exemption, he could investigate and correct the social security number.

FURTHER COMMENT: The IRS argued that it could not calculate the tax because it had rejected the return. I consider this argument sophistry, at best. The IRS could simply reject a return ... some returns … all returns … and make the same argument.

But Mr S could not provide a copy of the return.

Why not? Who knows. I suppose he never kept a copy and later lost the username and password to the software.

The Court cut him no slack. To conclude that the return met the Beard standard, the Court had to … you know … look at his return.

That left his second argument: reasonable cause.

The Court again cut him no slack.

The Court said that he should have logged back into TurboTax and yada yada yada.

Seems severe except for one thing: how could Mr S fail to realize that he never got dinged with an almost-$400 thousand bank transfer? I get that he carried a large bank balance, but reasonable people would pay attention when moving $400 grand.

Mr S could not provide a copy of his return nor could he explain how he could blow-off $400 grand. The Court was not buying his jibe.

There was no Beard for Mr S, nor was there reasonable cause to abate the penalty.

OBSERVATION: It occurs to me that Mr S may have received no advantage from the dependency exemption. This case involves a 2012 tax return, and for 2012 it is very possible that the alternative minimum tax (AMT) applied to this return. The AMT serves to disallow selected tax attributes to higher-income taxpayers – attributes such as a dependency exemption (I am not making this up, folks). The Court did not say one way or the other, but I am left wondering if he was penalized for something that did not affect his ultimate tax.

Our case this time was Spottiswood v US.

A Sad Grandma Story

 You know a tax case is going to irritate when you read this sentence early on:

The Commissioner does not defend the justice of this result, but says the law requires it.”

The story involves a grandmother, a son and daughter-in-law and two grandkids. Grandma appears to be the only one working and that as a nursing assistant in Texas. She also collected social security, which was just enough to keep the household afloat.

          []’s job is hard, and it does not pay much.”

It was 2012. He son did not work. Her daughter-n-law…

          … stayed home and took care of the babies.”

She filed her 2012 tax return and claimed the two grandchildren as dependents. That made sense, as she was the only person there with a job.

This allowed her to claim head of household and the dependent exemptions. Much more important than that, however, it allowed her to claim the child and earned income credits. She got a refund of almost $5,300, almost half of which was those credits.

Good for grandma.

The IRS sent her a notice. They wanted the money from the credits back.

Being the warm, fuzzy IRS we have come to know, she was also assessed a $1,000 penalty.

She figured ID theft. Somebody else must have claimed the kids.

She was right, partially. Somebody else did claim the kids.

Their parents.

That would be her son, the one who …

… did not work, and he was into dealing with drugs.”

Sigh.

We all know what a child is, but in the tax Code must rise to the level of a “qualifying child” before the tax goodies flow. There are requirements, of course – such as age and where they live – and grandma easily met those.

But only one person can claim each qualifying child, which is why one is required to include dependent social security numbers on the return. The IRS tracks those numbers. If you are the second person to use a dependent’s number, the IRS will bounce (or at least hold up) your return.

Grandma was the second to file, so she got bounced.

Now, there are families where more than one person can say that a child was his/her qualifying child. Congress anticipated this and included tie-breaker rules. For example, if two people contest and have equal claim, then the tie-breaker goes to the person with more income.

Or if the parents and someone else claim, then the parents win the tie-breaker.

However, this can be sidestepped if the parents DO NOT claim the child.

In grandma’s case, her son and daughter-in-law filed and claimed.

Can this situation be saved?

You bet.

How?

Amend the return. Have the parents “unclaim” the kids.

To their credit, the son and daughter did amend. They handed the amended return to the IRS attorney.

And here we have the technicality that makes you cringe.

Filing a return means sending it on to a service center or handing it to “any person assigned the responsibility to receive hand-carried returns in the local Internal Revenue Service office.”

Problem: the IRS attorney is not “assigned the responsibility” to receive or handle returns. Handing him/her a return is the equivalent of giving your return to a convenience store clerk or a Starbucks barista.

I suppose the attorney could bail you out by filing the return on your behalf upon returning to the office, but that did not happen here.

The return was never filed. Without an amended return, the son and daughter never revoked their dependency claim.

As the parents, they took priority over grandma, who only supported everyone that year.

And grandma could not claim the kids a second time.

Which cost her the child and earned income credits.

She had to repay the IRS.

The Court did not like this, not even a little bit.

We are sympathetic to []’s position. She provided all the financial support for …, had been told by her son that she should claim the children as her dependents, and is now stuck with a hefty tax bill. It is difficult for us to explain to a hardworking taxpayer like [] why this should be so, except to say that we are bound by the law.”

Sad.

At least the Court reversed those blasted penalties.

Spotting A (Tax) Dependent

Let’s talk about claiming someone as a dependent.

There are several tax “breaks” that require you to have a dependent, for example:

·        Head of household (HoH) filing status

·        A dependent exemption

·        Child credit

·        Child care credit

·        Education credit

·        Earned income credit

Some of these breaks go only so far. The head of household (HoH) filing status, for example, can get you to zero tax, but it cannot “create” a tax refund. You have to have tax withholdings before HoH can get you a refund; even then, you are getting your own money back. Not so with the child credit or the earned income credit, however.  Meet all the triggers and the EIC can refund you over $6,000, irrespective of whether you have any withholdings or not. It is a transfer payment from the government.

So what is required to claim someone as a tax dependent?

There are two overall categories of dependents. The first is your own child (or stepchild, adopted child, or descendants of the same) and is referred to as a “qualifying child.” This is the workhorse test: think a child at home with his/her parents.

There are five requirements for a “qualifying child”:

1. Are they related to you? 
2. Are they under age 19 or – if a full-time student – under age 24? 
3. Do they live with you for more than half the year?
4. Do you support them financially? 
5. Are you the only person claiming the child?

Any other type of dependent is a referred to as a “qualifying relative.” The requirements are as follows:

1. Do they live with you for more than half the year?
2. Do they make less than $3,950?
3. Do you support them financially?
4. Are you the only person claiming the child?

The term “qualifying relative” is misleading, by the way. The person does not need to be related to you at all. For example, a girlfriend could be my dependent – assuming that all the other requirements were met AND my wife allowed me to have a girlfriend.

Did you notice the age thing? A qualifying child ends at age 24 (unless we are talking permanent disability, which is a different rule). Past age 23 and the child is your dependent under the qualifying relative rules.

Which also means that an income test kicks-in. That after-age-23 child would not qualify as a dependent if he/she earned more than $3,950 for the year. This can be a cruel surprise at tax time for parents whose kids have moved back.

That answer, by the way, is the same for an over-18-under-24 child who does not go on to college.

Let’s take a little quiz on dependents. We will use the Tax Court case of James Edward Roberts v Commissioner. Here are selected facts:

1. In January, 2012 Roberts’ daughter became homeless. 
2. She had two young kids. 
3. She was pregnant with the third.

Roberts was a decent soul, and worked out a deal with a Ms. Moody, whereby he and the two children (very soon three) moved in with her. He agreed to pay 75% of the rent and utilities. He also agreed to pay 100% of the meals.

Then he did something unexpected. He wrote down the agreement, and both he and Ms. Moody signed and dated it.

Roberts and his (now three) grandchildren lived in the apartment from January until October, 2012. His daughter also lived there on-and-off. When she was not there, Ms. Moody helped take care of the kids.

When Roberts filed his 2012 tax return, he claimed the following:

(1)  Head of household

(2)  Dependent exemption for three grandchildren

(3)  Child credit

(4)  Earned income credit

The IRS bounced his return, and they wound up in Tax Court.

The IRS had an issue whether the kids were his dependents.

What do you think?

Let’s walk through it.

·        The kids are related (grandchildren) to Roberts. CHECK

·        The kids are young. CHECK

·        They lived with him from January through October, which is more than half the year. CHECK

·        He paid 75% of the rent and utilities and 100% of the food. Sounds to me like that would be over half the support for the kids. CHECK

·        The Court tells us that their mom did not claim them. CHECK

Seems that Roberts met all the requirements to claim the grandchildren as dependents for 2012. Why did the IRS press on this?

I don’t know, and the Court did not explain why. I can guess, though.

I see a person who…

·        moved

·        put three dependents on his return who were not there the prior year

·        was not living with the kids by the time the IRS contacted him

·        lived in an apartment with someone who (perhaps, who knows) might have been his girlfriend. This would raise the issue of who actually paid the expenses for rent, utilities and food – you know, the same expenses that Roberts needed to show that he supported the kids.

Roberts won his day in Court.

I suspect that written – and contemporaneously signed - agreement with Ms. Moody carried a lot of weight with the Court.

I allow that the IRS had cause to look at this return. After that, however, they should have left Mr. Roberts alone.  The IRS made a mistake on this one.

A Letter To The IRS

This is an actual letter sent to the IRS approximately 15 years ago Remember to laugh at least once daily. Enjoy!

Sirs:

I am responding to your letter denying the deduction for two of the three dependents I claimed on my 1994 Federal Tax return. Thank you!

I have questioned whether or not these are my children for years. They are evil and expensive. It's only fair that, since they are minors and no longer my responsibility, the government should know something about them and what to expect over the next year. Please do not try to reassign them to me next year and reinstate the deduction. They are yours!

The oldest, Kristen, is now 17. She is brilliant. Ask her! I suggest you put her to work in your office where she can answer people's questions about their returns. While she has no formal training, it has not seemed to hamper her mastery of any subject you can name. Taxes should be a breeze. Next year she is going to college. I think it's wonderful that you will now be responsible for that little expense. While you mull that over, keep in mind that she has a truck. It doesn't run at the moment, so you have the choice of appropriating some Department of Defense funds to fix the vehicle, or getting up early to drive her to school. Kristen also has a boyfriend. Oh joy! While she possesses all of the wisdom of the universe, her alleged mother and I have felt it best to occasionally remind her of the virtues of abstinence, or in the face of overwhelming passion, safe sex. This is always uncomfortable, and I am quite relieved you will be handling this in the future. May I suggest that you reinstate Dr. Jocelyn Elders who had a rather good handle on the problem.

Patrick is 14. I've had my suspicions about this one. His eyes are a little closer together than those of normal people. He may be a tax examiner himself one day, if he is not incarcerated first. In February, I was awakened at three in the morning by a police officer who was bringing Pat home. He and his friends were TP'ing houses. In the future, would you like him delivered to the local IRS office, or to Ogden, UT? Kids at 14 will do almost anything on a dare. His hair is purple. Permanent dye, temporary dye, what's the big deal? Learn to deal with it. You'll have plenty of time, as he is sitting out a few days of school after instigating a food fight in the cafeteria. I'll take care of filing your phone number with the vice-principal. Oh yes, he and all of his friends have raging hormones. This is the house of testosterone and it will be much more peaceful when he lives in your home. DO NOT leave him or his friends unsupervised with girls, explosives, inflammables, inflatables, vehicles, or telephones. (They find telephones a source of unimaginable amusement. Be sure to lock out the 900 and 976 numbers!)

Heather is an alien. She slid through a time warp and appeared as if by magic one year. I'm sure this one is yours. She is 10 going on 21. She came from a bad trip in the sixties. She wears tie-dyed clothes, beads, sandals, and hair that looks like Tiny Tim's. Fortunately you will be raising my taxes to help offset the pinch of her remedial reading courses. "Hooked On Phonics" is expensive, so the schools dropped it. But here's the good news!

You can buy it yourself for half the amount of the deduction that you are denying me! It's quite obvious that we were terrible parents (ask the other two). She cannot speak English. Most people under twenty understand the curious patois she fashioned out of valley girls/boys in the hood/reggae/yuppie/political double speak. The school sends her to a speech pathologist who has her roll her "r's". It added a refreshing Mexican/Irish touch to her voice. She wears hats backwards, baggy pants, and wants one of her ears pierced four more times. There is a fascination with tattoos that worries me, but I am sure that you can handle it. Bring a truck when you come to get her, she sort of "nests" in her room and I think that it would be easier to move the entire thing than find out what it is really made of.

You denied two of the three exemptions, so it is only fair that you get to pick which two you will take. I prefer that you take the youngest two, I will still go bankrupt with Kristen's college, but then I am free! If you take the two oldest, then I still have time for counseling before Heather becomes a teenager. If you take the two girls, then I won't feel so bad about putting Patrick in a military academy. Please let me know of your decision as soon as possible, as I have already increased the withholding on my W-4 to cover the $395 in additional tax and made a down payment on an airplane.

Yours truly,

Bob

By the way, the IRS allowed the dependency exemptions.