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On Mother’s Day Cowan Case Highlights Unfairness of Family Status Tax Rules

Posted on May 10, 2015

I wish all of our readers, especially the moms, a happy Mother’s Day. I dedicate this post to my mom, who this year is battling some serious health issues. Les

The working poor have a tough time making ends meet. When you consider costs of housing, child-care and transportation, the lot of the working poor is far from a picnic. To offset the costs of living, regressive employment taxes and the stagnation of low wages, the government uses the tax system in the form of credits like the EITC and additional allowances for deductions from gross income in the form of head of housing filing status and dependency exemptions.

When one reads about EITC and overclaim rate, you often see the term fraud. For example, a recent Tampa Bay Times PolitiFact.com piece discussed Rand Paul tarring EITC as having “about a 25% fraud rate.” PolitiFact called that a half-truth given the multiple causes for errors, only one of which is fraud. Yet reading quotes or headlines about fraud in EITC can make the blood boil, especially if you do not believe the government generally should play a role in redistributing wealth or if you think that Congress should not task the IRS with administering transfer programs.

Last week’s case of Cowan v Commissioner may also make your blood boil. It illustrates that the issues relating to erroneous claims of the EITC and other family status benefit provisions are often more nuanced than generally discussed.

In the case Jean Cowan cared for, supported and lived with Marquis Ward from the age of six weeks. At birth Marquis’ mother was addicted to drugs. Jean was appointed guardian of Marquis when he was 6 weeks old. Even after Marquis turned 18 Jean cared for, lived with and supported Marquis.  Marquis fathered a daughter, who also lived with and was supported by Jean for 11 months in 2011. (Jean had about $14,000 in AGI in 2011).

The case turned on the relationship between Jean and Marquis’ child; normally a grandparent’s living with and caring for a grandchild for greater than half of the year will generate eligibility for benefits like the EITC, CTC, dependency exemption and filing status.

Not in the Cowan case. That Jean was not biologically related to Marquis’ son meant that the child was not Jean’s child or descendant of such child for tax purposes.

The issue gets technical. For these purposes, as per Section 152(f)(1)(A) the term “child”– means an individual who is– (i) a son, daughter, stepson, or stepdaughter of the taxpayer, or (ii) an eligible foster child of the taxpayer.

For this purpose, an “eligible foster child” is defined as “an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.” Section 152(f)(1)(C).

Prior to Marquis turning 18, Jean would have been able to treat Marquis’ as an eligible foster child and by extension his daughter as a qualifying child. That is because until Marquis turned 18, he was considered “placed with” Jean pursuant to the state guardianship proceedings. Descendants of qualifying children are also qualifying children, so prior to the guardianship terminating, Marquis’ daughter could also be Jean’s qualifying child. When Marquis turned 18, under Ohio law, the guardianship terminated; there also was a court order explicitly terminating the guardianship.

Despite Marquis turning 18, Jean did what many parents do. She continued to support Marquis. She lived with him. When he fathered a child, Jean worked, lived with and cared for Marquis’ baby daughter. Yet, that was not enough under the rules:

Notwithstanding the phrase “is placed”, Ms. Cowan asserts that “the statute does not specify that the foster child ceases to be a child when they reach the age of majority.” It is true that section 152 does not specifically provide that a foster child ceases to be an “eligible foster child” upon reaching the age of majority; rather, it is Ohio State law that so provides and that terminated Marquis’s placement with Ms. Cowan. It is the interaction of State law (which defines the relationship) with section 152(f)(1)(A)(ii) (which allows the deduction) that removes Marquis from the ambit of its definition.

The legal conclusion followed:

It could not be said in 2011 that Marquis “is placed” with Ms. Cowan; rather, his legal placement with her had ended years earlier. Consequently, in that year he was not her “eligible foster child” and was not her “child” for purposes of section 152(c)(2)(A). As a result, his daughter, H.A.W., was not a “qualifying child” of Ms. Cowan by being a “descendant of * * * [her] child” under that section.

When the dust cleared, Jean had about a $4,000 deficiency based on a disallowed EITC, dependency exemption and HOH filing status. Those benefits effectively turned on Jean being allowed to treat Marquis’ daughter as if she were a grandchild.

Parting Thoughts

The confusing and at times complex family status definitions put IRS counsel (and Tax Court judges) in a tough spot. Counsel and the court are bound by the laws. Perhaps one can say IRS should have exercised discretion and not pursued the case, but as Bryan Camp’s post on tax myths last month discusses (see Myth 8, IRS is Run by Humans), there likely was no human being involved in exercising discretion until the case went to court. Prior to then, Jean was just one of the unlucky 500,000 or so EITC taxpayers a year whose return was selected for examination.

Reading the case makes me both sad and mad; sad for Jean who based on the facts in the opinion tried to do the right thing and mad that the tax system we have does not serve someone like her. To be sure, legal adoption might have fixed the problem, but that can be time consuming and expensive. In any event, the complexity of the rules makes it highly unlikely that working poor taxpayers understand the nooks and crannies of the qualifying child definition.

Admittedly, there is no easy fix for cases like this. Under old law, living with and caring for a child as if the child were your own generated eligibility for the EITC. Congress changed the law about 15 years ago, thinking that its open-endedness encouraged people to “share” children and commit fraud in claiming EITC.

Maybe so. But sometimes taxpayers try to do the right thing and the tax system fails them. It failed Jean here.

UPDATE 5.11

For more background on the history of the definition of child in the tax code (and other problems), see Heal the Suffering Children: Fifty Years after the Declaration of War on Poverty by Professors Francine Lipman and Dawn Davis, in the Boston College Journal of Law & Social Policy

There are a number of issues that limit the EITC’s effectiveness beyond that presented in the Cowan case. For example, see Professor Mary Pareja’s recent article in the West Virginia Law Review Earned Income Tax Credit Portability: Respecting the Autonomy of American Families, which  proposes portability to allow noncustodial parents the ability to claim EITC.

UPDATE 5.13

IRS conceded the dependency exemption for Marquis; the deficiency as a result of the concession is likely about $500 less than the $4,390 in the notice of deficiency. The post as originally written did not reflect the IRS’ concession of that issue.

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