Amendment of Internal Code Section 152(e) in Order to Better Reflect Taxpayer Reality and Ensure Taxpayer Saftey

• Publication year: 2018
• Author: By James Creech

Amendment of Internal Code Section 152(e) in Order to Better Reflect Taxpayer Reality and Ensure Taxpayer Saftey

By James Creech²

I. EXECUTIVE SUMMARY

IRC Section 152 is a lynchpin code section for many individual taxpayers. Section 152 defines who is a dependent for federal tax purposes. Under current law, who is a dependent, and who may claim the dependent, is determinative of who may claim certain deductions and credits.

Section 152(e) creates a narrow set of circumstances where a non-custodial parent may claim a dependent that lives with the other parent. In order for the non-custodial parent to claim a dependent, the custodial parent must sign a written declaration unconditionally stating that the custodial parent will not claim the dependent for a taxable year. It must name the parent who will claim the dependent and the tax year or years for which the release is valid. The non-custodial parent must attach the statement from the custodial spouse to their return. The regulations specifically state that a court order or separation agreement may not serve as a release for tax purposes.

These stringent regulations do not reflect taxpayer reality. The majority of separations or divorces are done either pro-se or by family law attorneys with no familiarity with the tax code. Taxpayers and their counsel are frequently unaware of Section 152's requirements. Taxpayers may not understand that the IRS is not bound by a family law court. However, in many instances, if the parties come to an agreement, it is likely that the only place the tax consequences are addressed is in the divorce decree. A taxpayer who relies solely upon the decree they will not meet the requirements of 152(e), even if they acted in good faith.

If the non-custodial spouse is disallowed the dependency, the applicable credits may go unclaimed and deductions may go unused. This harms both parties because there is less money for the family, and renders the underlying economic agreement between the parties useless.

A solution to this problem is to modify the regulations to allow a court order or signed agreement between the parties to satisfy the written document requirement of Section 152(e). This would allow the understanding between the parties to have economic effect, provide predictability, and better reflect the taxpayers¹ understanding of the tax consequences of the separation.

II. DISCUSSION

A. Introduction

One of the most important factors of for determining the correct amount of tax due for many individual taxpayers is how many dependents they may claim. IRC Section 152 defines who is dependent. Section 152 contains a number of requirements designed to make sure that the taxpayer claiming the dependent is in fact the one supporting the dependent. Section 152(c) contains a residency test which requires a qualifying child to live with the taxpayer for more than one half of the taxable year.

IRC Section 152(e) allows for a limited exception to the residency test under 152(c). A non-custodial parent may claim a dependent who lives with the custodial parent if the custodial parent signs a written declaration stating they will not claim the dependent for a particular tax year or years.³ During the creation of 152(e), Congress delegated the power to determine what qualifies as a valid written declaration to the Secretary of the Treasury as part of the regulation writing process.

When Treasury drafted the regulations, they created a system that focused more upon the ease of administration than the needs of the taxpayers. This focus on ease of administration is misguided because it creates barriers with which the average taxpayer who wishes to take advantage of Section 152(e) may not be able to comply, even with a good faith effort to do so.

Beyond an inability to comply, the language of the Treasury Regulations may mean that taxpayers are forced to remain in contact with their former partner, despite physical or mental abuse. The regulations also create long-term uncertainty for taxpayers. Since claiming dependency can change year to year, and the custodial spouse has unlimited power to revoke their consent, the non-custodial parent is always at risk of unilateral revocation of their ability to claim the dependent even if the revocation is done for non-tax related reasons. It is time for Congress, and the Department of the Treasury, to reevaluate these requirements in light of who the intended beneficiaries are and their ability to comply without guidance.

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B. Legislative History

The current version of Section 152(e) was enacted as part of the Tax Reform Act of 1984. Prior to the 1984 amendment, Section 152(e) existed as a three-part factual test. The first two prongs were dollar indexed support tests. The third prong was based upon the parties' agreement with regards to who should claim the dependent. Each of the three tests was a factual test that required significant efforts on behalf of the IRS to make a determination. As a result of the vagueness of Section 152's language, most of IRS's time and energy was spent determining what was the dollar amount spent providing "support" under the first two prongs, given that what constituted "support" was not clearly defined for purposes of Section152(e).

Given the fact-specific nature of Section 152(e) audits, the code section was targeted for reform in order to reduce IRS workload. The House Ways and Means Committee report cited a desire to make determinations of who properly claimed a dependant easier on the Service, while still allowing for dependency shifting between taxpayers.⁴The new Section 152(e) dropped both of the means tests and focused solely on the agreement between the parties. Under the new Section 152(e), if the parties entered into a written agreement stating that the non-custodial spouse was unconditionally entitled to claim the dependent, they were legally allowed to do so. The new Section 152(e) enabled the IRS to perform a cursory check of the non-custodial spouse's return in order to determine if the requirements have been met. If the agreement was revoked, or failed the requirement of Section 152(e), then the custodial spouse who met the requirements of Section 152(c) would be entitled to claim the dependent.

As the committee...