The AICPA looks at the uniform definition of a child.

• Author: Cook, Ellen D.

EXECUTIVE SUMMARY

* Under the UDOC, as adopted in the WFTRA, a qualifying child must satisfy the abode, relationship and age tests.

* The UDOC provides a uniform definition for five of the child-based benefits, but unintended results have led to calls for corrective action.

* The Administration's fiscal-year 2007 revenue proposals include several provisions to solve some of the UDOC's problems and issues.

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As established by the Working Families Tax Relief Act of 2004, the uniform definition of a child (UDOC) provides a definition for five different child-based benefits. This article focuses on the unintended results of the UDOC and examines some proposed solutions.

The inclusion of a uniform definition of a child (UDOC) as part of the Working Families Tax Relief Act of 2004 (WFTRA) (1) represented the culmination of simplification efforts in the area of family taxation by the Bush Administration, the Joint Committee on Taxation (JCT), Treasury, the National Taxpayer Advocate (NTA) and professional organizations, including the AICPA, the American Bar Association (ABA) and the Tax Executives Institute (TEI). While the final legislation includes a uniform definition for five of the child-based benefits--the Sec. 152 dependency exemption, the Sec. 32 earned income tax credit (EITC), the Sec. 24 child credit, the Sec. 21 child and dependent care credit and Sec. 2(b)(1) head-of-household (HOH) status--unintended results have led to calls for corrective action. The Administration's fiscal-year 2007 revenue proposals (2) include a number of provisions aimed at solving some, but not all, of the problems raised before and during the 2006 filing season. A handful of tax professionals have called for the repeal of the UDOC, and at least one bill currently before Congress would do just that. (3) This article examines the UDOC's development and basic rules, the unintended results and potential corrective actions.

Development of the UDOC

In its 2001 report on tax simplification, the JCT stated that adopting a uniform definition of a qualifying child would make it easier for taxpayers to determine whether they qualify for the various tax benefits for children and to reduce inadvertent taxpayer errors arising from confusion due to different definitions. It recommended a residency test as the basis for the uniform definition, because it is easier to apply than a support test. (4)

Treasury, in 2002, issued "Proposal for Uniform Definition of a Qualifying Child," (5) which called for a three-pronged test--relationship, residence and age--in determining a qualifying child for purposes of the five child-based benefits. The proposal eliminated both the support and gross income tests, as well as the household maintenance test used to claim the child and dependent care credit. Treasury reported that 52 million taxpayers would benefit from the simplification, by reducing both taxpayer confusion over differing definitions and the recordkeeping burdens of the support and maintenance tests. More recently, the NTA reported that the family-based tax benefits affect 81 million taxpayers and 79 million children. (6)

The proposal garnered general support from the AICPA, ABA and TEI, as reported in their September 2002 "Tax Simplification Recommendations." (7) Their joint letter commended Treasury, the NTA and the JCT, but recommended several changes to the proposal, some of which are discussed below.

"Care For" Test

In defining familial and adoptive relationships that qualify for child sums, in addition to "traditional" relationships (i.e., children, stepchildren and their descendants), Treasury's proposal stated, "if the child is the taxpayer's sibling or stepsibling or a descendant of any such individual, the taxpayer must care for the child as if the child were his or her own child." While the AICPA, ABA and TEI agreed that siblings, stepsiblings and their dependents should be included in the definition of qualifying relationships, they felt that the language was, in essence, a "backdoor support test" that was vague and would be hard to administer. They recommended eliminating the phrase, a view consistent with that of the JCT, noting that the tie-breaker rules and residence test would be sufficient to avoid any potential abuses. While the phrase was eliminated by the WFTRA, as discussed below, its elimination has led to both hardships and abuses.

Tradability of Dependency Exemption

Treasury's proposal awarded the child-based benefits, in the case of divorce, to the custodial parent and prohibited release to the noncustodial parent except in the case of grandfathered child-support agreements. The AICPA, ABA and TEI disagreed with the non-tradability feature of the dependency exemption. In the end, the WFTRA provided that a child is considered the qualifying child or qualifying relative of the custodial parent, unless (1) under the divorce or separate maintenance agreement, the noncustodial parent is entitled to the dependency exemption or (2) the custodial parent signs a written declaration stating that he or she will not claim the child as a dependent. However, the Gulf Opportunity Zone Act of 2005 (8) included amendments to the WFTRA that revert to prior law and do not recognize a divorce decree in determining the dependency exemption, but, rather, give the exemption to the custodial parent (who may sign it over to the noncustodial...