Inequitable administration: documenting family for tax purposes.

• Author: Infanti, Anthony C.
• Position: II. Deductions, Credits, and Exclusions A. Documenting Relatives and Other Family Members 3. Overlap with Exclusions Relating to Dependents through III. Attribution Rules A. The s. 267 and s. 318 Attribution Rules 4. Limited Documentation Required, p. 361-401

3. Overlap with Exclusions Relating to Dependents

   1. Fringe Benefits

      These same variations and gaps are found in Code provisions that afford exclusions from gross income. The Code provisions that allow a taxpayer to exclude from gross income fringe benefits provided to family members by an employer include [section] 101 (survivor benefits provided to family members of a public safety officer killed in the line of duty), [section][section] 105 and 106 (employer-provided medical care), [section] 117 (tuition benefits provided to the family members of an employee of an educational organization), [section] 119 (employer-provided meals and lodging), [section] 129 (employer-provided dependent care assistance programs), [section] 132 (no-additional-cost services, qualified employee discounts, and qualified moving expense reimbursements), and [section] 134 (military benefits). (92) With the exception of [section][section] 119 and 134, which adopt definitions of "dependent" that are coextensive with that employed by [section] 151, there are gaps between the coverage of these exclusions and the identification and documentation requirement of [section] 151(e). Interestingly, however, recordkeeping requirements that apply to employers fill in all of these gaps in coverage and ensure the identification and documentation of all dependents eligible for these exclusions, regardless of whether the taxpayer can claim them as dependents for purposes of the personal exemption.

      Employers who are required to deduct and withhold income tax from the wages of their employees must keep records regarding (I) the total remuneration paid to each employee and (2) the portion of this remuneration that constitutes wages subject to withholding. (93) Employers are further required to keep records regarding the reasons for any discrepancy between these two amounts. (94) In other words, it is up to the taxpayer's employer to ask the taxpayer/employee to document her claim for an exclusion from gross income (and, in turn, exemption from withholding (95)) and to retain the records supporting that claim. Through these recordkeeping requirements, the federal government has gone far beyond merely establishing a baseline of identification and documentation. By filling in all of the gaps in the de facto documentation requirement of [section] 151(e) as it applies to these exclusions, the federal government has mandated identification and documentation as a prerequisite to obtaining tax-free fringe benefits for a taxpayer's dependents. (96)

   2. Other Exclusions

      A few exclusions do not involve employer-provided benefits. For example, [section] 135 permits a taxpayer to exclude from gross income interest on U.S. savings bonds used to pay the higher education expenses of a dependent. (97) Even though this exclusion is restricted to dependents for whom a personal exemption may be claimed under [section] 151, the IRS nonetheless requires the taxpayer to identify the dependent whose educational expenses were paid with the redeemed U.S. savings bond. (98)

      Sections 529 and 530 provide additional incentives for education by according favorable tax treatment to qualified tuition programs (QTPs) and Coverdell educational savings accounts (Coverdell ESAs). Both QTPs and Coverdell ESAs benefit from tax-free growth of amounts contributed or saved (i.e., the earnings on contributions to the account are excluded from the gross income of the contributor and the beneficiary), and distributions from these accounts to designated beneficiaries are tax free so long as they do not exceed the beneficiary's qualifying educational expenses. (99) A taxpayer who opens a Coverdell ESA or an account with a QTP is permitted to change the designated beneficiary to another member of the current beneficiary's family without adverse tax consequences. (100) Apparently relying on the trustees of Coverdell ESAs and the administrators of QTPs to police compliance with the requirement that the new beneficiary be a member of the existing beneficiary's family, little or no reporting of a change in beneficiary is required. (101)

      In a different vein, [section] 139D allows taxpayers to exclude the value of "qualified Indian health care benefits," including certain health care benefits provided to the dependents of members of an Indian tribe. This provision was enacted in March 2010 as part of healthcare reform; it therefore remains to be seen whether the IRS will issue any notices, forms, or regulations that require identification or documentation of the taxpayer's dependents who qualify for this exclusion but fall outside of the de facto documentation requirement of [section] 15 1 (e). (102)

      With their mix of duplicative documentation requirements, shifting of responsibility for policing compliance, and potential for underdocumentation, these provisions share the haphazard approach to identification and documentation of a taxpayer's dependents encountered in the deduction and credit provisions discussed in the previous two sections of this Part.

4. Overlap with Tax Disallowances Relating to Dependents

   In some cases, Code provisions disqualify payments to relatives from eligibility for a deduction or credit. For example, payments to a taxpayer's dependents and children under the age of nineteen are ineligible for the dependent care assistance credit and are likewise ineligible for the exclusion for employer-provided dependent care assistance programs. (103) A taxpayer claiming the dependent care assistance credit or the exclusion for an employer-provided dependent care assistance program must identify and document all persons who provide dependent care services for which a credit or exclusion is claimed, notwithstanding that those who are dependents would already have been documented on the first page of the return, as mandated by [section] 151(e). (104)

   Section 213(d)(11) renders amounts paid for long-term care services provided by a relative ineligible for deduction as medical expenses, unless the relative is a licensed professional. For this purpose, a "relative" is defined as "an individual bearing a relationship to the individual which is described in any of subparagraphs (A) through (G) of section 152(d)(2)." (105) In some cases, these relatives will be claimed as dependents on the return and in others they will not (e.g., because they fail to meet other prongs of the definition of "dependent" for purposes of [section][section] 151 and 152). (106) Nevertheless, [section] 213 does not require taxpayers to identify or document any of the individuals to whom payments for long-term care services are made. (107)

   Under [section] 170(g), a taxpayer may take a charitable contribution deduction for amounts paid to maintain an individual in her home in connection with that individual's participation in an educational program, so long as the individual is neither a dependent nor a relative of the taxpayer. (108) For this purpose, the definition of "dependent" is borrowed from [section] 152, but it is broadened by statute to include individuals who fail to meet selected elements of that definition (viz., the no .joint return requirement and the gross income cap). (109) Again, a "relative" is defined as "an individual bearing a relationship to the individual which is described in any of subparagraphs (A) through (G) of section 152(d)(2)." (110) Though taxpayers claiming a deduction under [section] 170(g) are required to submit a significant amount of information with their tax returns in support of the deduction, a statement regarding the taxpayer's relationship to the student is not required--nor, apparently, is even identification of the student explicitly required so that the student's name might be matched with the persons claimed as dependents on the front of the taxpayer's return. (111)

   Newly enacted [section] 45R permits certain small employers who provide health insurance coverage to their employees to claim a credit against their income tax. (112) Certain owners of the business, their family members, and some of their dependents are not taken into account as employees in calculating the amount of this credit. (113) Though the IRS has provided taxpayers guidance on claiming the credit, it remains to be seen whether the IRS will require identification or documentation of the employer's relationship to employees with respect to whom the credit is claimed. (114)

   These provisions either overfill compliance gaps in the de facto documentation requirement of [section] 151(e) or leave them wholly unfilled, further contributing to the haphazard patchwork of identification and documentation requirements that apply to a taxpayer's dependents.

   Before turning to a discussion of documenting spouses in the next section, it is worth pausing for a moment to peruse a tabular representation of the numerous provisions discussed so far in this Part. Table 1 summarizes this discussion by first listing each of the Code sections mentioned above. The next two columns...