The Tax Significance of Identifying Dependentsby
This article’s focus is not so much a detailed definition of “dependent,” but helping the tax professional identify and plan for benefits that may turn on such a relationship (See IRS interview at “Whom May I Claim as a Dependent,” IRS.gov).
The many different tax benefits available to your clients largely depend on having one or more dependents.
To start with, Section 151 allows personal exemptions, which are not currently available. However, the definition of “dependent” found in Section 152 is still important in these years.
A seasoned tax professional may recall the dependency exemption hasn’t been available since 2017, when the exemption amount (which is adjusted annually for inflation) was $4,050. This benefit is scheduled to return after 2025, but now we generally have a multitude of special benefits to consider.
A dependent is generally defined as a qualifying child or qualifying relative but with each component subject to many details (Section 152(a); see IRS Pub. 501, “Dependents, Standard Deduction, and Filing Information,” for use in preparing 2021 returns, p. 11 and generally).
Dependents can even affect filing status. “Surviving spouses who have a dependent child may be able to use the Qualifying Widow(er) status in the two tax years following the year of the spouse’s death.” (IRS Pub. 4491 “Volunteer Income Tax Assistance (VITA), Tax Counseling for the Elderly,” 2021 returns, p. 4-5). The publication uses “dependent” many times.
We note that being a dependent can minimize one’s standard deduction. In general, a dependent’s standard deduction is limited in 2021 to the greater of $1,100, or earned income plus $350 (subject to some maximum rules)(Sec. 63(c)(5)). The standard deduction may be higher if the individual is 65 or older, or legally blind.
Normally subject to a $5,000 maximum or $2,500 if married filing separately, an employee can exclude employer payments for dependent care assistance (Sec. 129). The 2021 exclusion was significantly increased to $10,500, or $5,250 if married filing separately. The dependent care assistance income exclusion can also reach military personnel (Sec. 134(b)(4)).
Note the employee requirement here, which from a planning standpoint introduces the employee vs consultant distinction. There are, of course, disadvantages to classification as an employee, particularly the current itemized deduction disallowance of almost all employee business expenses.
Distinct from the exclusion for employer payments is the child and dependent care expense credit. (Sec. 21, Form 2441; See generally “Advantages of Dependent Care Assistance Programs,” Mike Pusey, Accountingweb.com, May 10, 2021; “Child and Dependent Care Credit FAQs,” IRS.gov).
Child Tax Credit
The 2021 initial credit is generally increased to $3,600 if the child has not attained age six by the end of 2021, and $3,000 for each other qualifying child who has not attained the age of eighteen by the end of 2021 (Section 24, Form 8812 and instructions).
The return will need to include not only the dependent’s name but taxpayer identification number. A qualifying child without an identification number may qualify as another dependent.
The child identification number requirement comes up even in the context of adoption expenses, while the touchstone there, given the “getting started” nature of the topic, is “eligible child” rather than dependent (Section 23). The child tax credit is phased out at relatively high levels of adjusted gross income.
Recovery Rebate Credit
The dependent question can affect 2021’s “recovery rebate credit.” (Sec. 6428(d)(2)).
“If you can be claimed as a dependent on someone else’s 2021 tax return, then you cannot claim a dependent on your tax return. You also cannot claim the 2021 Recovery Rebate Credit.
The 2021 Recovery Rebate Credit includes up to an additional $1,400 for each qualifying dependent you claim on your 2021 tax return. A qualifying dependent is a dependent who has a valid Social Security number or Adoption Taxpayer Identification Number issued by the IRS.
A valid SSN for the 2021 Recovery Rebate Credit is one that is issued by the Social Security Administration by the due date of your 2021 tax return (including an extension if you requested the extension by the due date). To claim a person as a dependent on your tax return, that person must be your qualifying child or qualifying relative…..” (See the lengthy discussion at “2021 Recovery Rebate Credit – Topic C: Eligibility for claiming a Recovery Rebate Credit on a 2021 tax return,” Q C7, IRS.gov. See also Q C8 and C9).
Earned Income Tax Credit
For 2021, the maximum credit ranges from $1,502 to $6,728 depending on the number of children and filing status (See “Earned Income and Earned Income Tax Credit (EITC) Tables,” IRS.gov.))
The earned income tax credit is found in section 32 which defines a “qualifying child” relying rather heavily on the trail of section 151 and 152 for the definition of a “dependent.” (See also Schedule EIC Form 1040). Eligibility for the credit turns on the taxpayer not being a dependent of another taxpayer.
Health Insurance Premium Assistance Credit
This credit isn’t available to someone that can be claimed as a dependent of another person (Sec. 36B(c)’(1)(D)). The Form 8962 asks such questions as “the total of your dependents’ modified AGI (adjusted gross income).”
One can see various nuances to the rules searching “dependent” in the instructions to Form 8962. “Family size” for purposes of these calculations generally includes dependents.
Health Coverage Tax Credit
This credit under Section 35, claimed on Form 8885, is generally 72.5 percent of costs during coverage months of the year. This measure of certain health insurance costs focuses on a “qualifying family member” which generally reaches the taxpayer’s dependents. ((Sec. 35(d)(1)(B) incorporating Sec. 151(c)). Advance payments may result in the taxpayer receiving a Form 1099-H from the health plan’s administration group.
Sale of Principal Residence
The definition of what constitutes a “principal residence” can consider any number of factors, including being the “principal place of abode of the taxpayer’s family members.” (Regs. 1.121-1(b)(2)(ii)). We note a private letter ruling using the phrase “certain family members” without significant commentary. See PLR 200626024 (6/30/06) citing Regs. 1.121-3(f). See also the regulations mitigating the requirements in some cases when the taxpayer’s move triggers home sales for reasons of health of a qualified individual. (Regs. 1.121-3(d)).
Here the definition of qualified individuals includes family relationships under the personal exemption rules of section 152(a)(1) through (8) but without having to qualify as a dependent (Regs. 1.121-3(f)). This is an instance in which the concept of dependent is a focus yet there are deletions from the definition such that full qualification as a dependent isn’t required. So, as usual, the tax adviser’s research needs to focus on particulars of the provision.
Our topic can arise can arise in connection with deducting student loan interest (Sec. 221, “Topic No. 456 Student Loan Interest Deduction,” IRS.gov.) The tax nuances of finding a dependent are many.
“Identifying and determining the correct number of dependents is a critical component of completing the taxpayer’s return. The deduction for personal and dependency exemptions is suspended for tax years 2018 through 2025 by the Tax Cuts and Jobs Act.
Although the exemption amount is zero, the ability to claim a dependent may make taxpayers eligible for other tax benefits. For example, the following tax benefits may all be associated with a dependent: child tax credit, additional child tax credit, credit for other dependents, earned income credit, child and dependent care credit, head of household filing status, and other tax benefits.” (IRS Pub. 4491 “Volunteer Income Tax Assistance (VITA), Tax Counseling for the Elderly,” 2021 returns, p. 5-3).
The number of complex topics where the concept of “dependent” has importance suggests that identifying them is a high priority for the tax professional. The topic of “dependent” is important in both compliance and planning for the client. It will often be an important focus at the beginning of the taxpayer interview.
Mike Pusey, CPA served as National Tax Director at Rojas & Associates. He has a BBA and Master of Science in Accounting from Texas Tech where he graduated with honors. He planned to be an accounting professor and worked a year on the Ph. D. at the University of Arizona before beginning his career at KPMG Peat Marwick, where he worked in...