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The Tax Law, EITC and Modern Families: A Bad Mix

Posted on July 30, 2014

I read a summary Tax Court case from a few weeks ago that reminds me that the tax laws in general– and the EITC and Child Tax Credit rules in particular– can sometimes lead to unfair results, especially in light of the complicated and at times messy modern family lives. The case, Gutierrez v. Commissioner, involves an unmarried taxpayer who lived with his girlfriend and her children. It highlights the relationship between the sometimes conflicting goals of improving compliance and providing benefits to working families. It also highlights a tax procedure issue relating to eligibility for EITC refunds in a year when a taxpayer’s qualifying child may not have a Social Security number, but subsequently obtains one.

What follows is a brief discussion of the case and the related procedural issue.

The Gutierrez Case

Martin Gutierrez lived with his girlfriend and her two minor children in 2011. In 2011, Martin supported the household. He filed as head of household and claimed his girlfriend’s two kids as dependents and qualifying children for the CTC and EITC. IRS examined Martin’s 2011 tax return. IRS disallowed his HOH filing status, dependents, CTC and EITC.

Martin married his girlfriend in 2013; the same year Martin became a “custodial parent” of her two minor children by order of the Superior Court of Arizona.

Martin filed a petition to Tax Court challenging the IRS’s 2011 adjustments. IRS conceded the filing status and dependency exemption adjustments but litigated the EITC and CTC issues.

The opinion is brief. It states that to claim kids as qualifying children for the EITC and CTC the taxpayer must satisfy a relationship test under Section 152(c); in 2011, Martin flunked the relationship test because the kids were not his biological kids nor were they his stepchildren until he married their mother in 2013.

That’s about it. Martin loses on EITC and CTC and has to pay back a few thousand bucks (or does not get the refund; the opinion does not state if the matter is a refund freeze).

I have no quibble with the legal analysis in the case.

The case raises interesting cultural issues about what it means to be a parent, the notion of family, and how the tax law definition of family at times clashes with how people live.  Up until 2000 a child could be treated as a qualifying child for EITC if the taxpayer lived with the child and treated the child as if the child were her/his own.  Congress eliminated that out of its concern with EITC overclaim rates; allowing a taxpayer to claim unrelated kids tempted taxpayers (and preparers standing to benefit from juiced up refunds) to more readily share children, and the standard was hard to prove (or disprove) in a correspondence exam.

Now I agree that the “care for as your own” standard perhaps tempted preparers and taxpayers alike to engage in improper child sharing but it likely would have allowed Martin to claim the kids he lived with, supported and eventually could claim as qualifying children following his marriage.  The old standard that was available pre-2000 is much more reflective of modern families than the current standard which values expedience over reality and limits benefits to a specific and perhaps unrealistic notion of what types of families should benefit.

To be sure, in a complicated body of law Congress has to draw lines, and this is not the only place where the Code prefers married taxpayers to unmarried taxpayers. Sometimes expedience and compliance concerns trump fairness. No doubt that error rates are a legitimate concern, but so is providing support for people who work, live with and care for minor children.

What About Allowing a Taxpayer to Benefit When in a Later Year The Child is a Qualifying Child?

Tying family-related tax benefits to a child with a valid Social Security number is a hot button political issue. See for example this story this past week from The Hill discussing how Republicans believe requiring a child to have a social security number for CTC claims will limit fraud. The EITC has that limit; Congress has been kicking around legislation tethering the CTC to that as well, with the House passing legislation to that effect.

When I read Gutierrez I was reminded of a Chief Counsel Advice from 2000  (CCA 200028034; Jul 14, 2000) that concerned a child who did not have a Social Security number in Year 1 but subsequent to the original due date and Year 1 filing obtains one. At the time the Year 1 return was due, due to the child not having a Social Security number, the taxpayer could not have claimed the child as a qualifying child for the EITC. The CCA, however, says that so long as the sol on refunds is open for Year 1, the taxpayer could go back and amend the Year 1 tax return and claim the EITC based upon the child later having a valid Social Security number.

The legal issue is different in Gutierrez, as the relationship of a child is an element of the definition of qualifying child, while the Social Security requirement discussed in the CCA was a prerequisite for claiming the credit and not an essential definitional element. Yet, the CCA’s approach of allowing a taxpayer to use later events to justify earlier eligibility would be fairer for someone like the taxpayer in Gutierrez. It also is not readily subject to abuse.

Congress is often justifiably concerned with overclaims. It should also be concerned with taxpayers like Martin Gutierrez, who work and support their families.

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