Proposed Regs Clarify the Definition of Qualifying Relative for Years 2018-2025

(Parker Tax Publishing June 2020)

The IRS issued proposed regulations that clarify the definition of a "qualifying relative" for purposes of various provisions of the Code for tax years 2018 through 2025. The proposed regulations also withdraw a portion of the proposed regulations published in 2017 addressing the support test for a qualifying relative, and propose replacement language in order to remove references to repealed Code sections. REG-118997-19.

Background

Generally, Code Sec. 151 allows a taxpayer to claim exemption deductions for the taxpayer and his or her spouse, and for any dependents. Under Code Sec. 152(a), a dependent means either a qualifying child or a qualifying relative. The definition of a "qualifying relative" in Code Sec. 152(d)(1) includes the requirement in Code Sec. 152(d)(1)(B) that the individual have gross income for the calendar year that is less than the exemption amount as defined in Code Sec. 151(d). Such an individual must also satisfy the requirement of Code Sec. 152(d)(1)(C) that the individual receive more than one-half of his or her support from the taxpayer claiming the individual as a qualifying relative.

Before being amended by the Tax Cuts and Jobs Act (TCJA), Code Sec. 151(d) provided for an exemption amount of $2,000 that was adjusted annually for inflation. Before the enactment of TCJA, the IRS had determined in Rev. Proc. 2017-58 (modified and superseded by Rev. Proc. 2018-18) that the exemption amount for calendar year 2018 was $4,150. TCJA added Code Sec. 151(d)(5) to provide special rules for tax years 2018 through 2025 regarding the exemption amount in Code Sec. 151(d). Code Sec. 151(d)(5)(A) provides that, for a tax year beginning after December 31, 2017, and before January 1, 2026, the exemption amount is zero, thereby suspending the deductions for personal exemptions and the dependency exemption. However, Code Sec. 151(d)(5)(B) provides that the reduction of the exemption amount to zero is not taken into account in determining whether a deduction under Code Sec. 151 is allowed or allowable to a taxpayer, or whether a taxpayer is entitled to a deduction under Code Sec. 151, for purposes of any other provision of the Code.

TCJA also amended Code Sec. 24 to create a $500 credit for certain dependents of a taxpayer other than a qualifying child described in Code Sec. 24(c) for whom the child tax credit is allowed. Under Code Sec. 24(h)(4), the $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed, and (2) qualifying relatives as defined in Code Sec. 152(d). This new credit applies for tax years 2018 through 2025.

The definition of "head of household" in Code Sec. 2(b)(1)(A) includes the requirement that the taxpayer maintain as his or her home a household for a qualifying individual for a specified period of time. A qualifying individual under Code Sec. 2(b)(1)(A)(ii) includes a qualifying relative if the taxpayer is entitled to a deduction under Code Sec. 151 for the person for the tax year. As noted above, taxpayers are allowed a deduction under Code Sec. 151 for individuals who are dependents as defined in Code Sec. 152, including qualifying relatives described in Code Sec. 152(d).

Prior to the enactment of TCJA, alimony and separate maintenance payments were deductible by the payor spouse and includible in income by the recipient spouse under Code Secs. 61(a)(8), 71(a), and 215(a). Under Code Sec. 71(c), child support payments were not treated as alimony. TCJA repealed Code Secs. 61(a)(8), 71 and 215, and, in a conforming change, also repealed Code Sec. 682, relating to the income of an estate or trust in case of divorce, for any divorce or separation instrument executed after 2018, and for any instrument executed before 2019 and later modified to apply the provisions of the TCJA. To conform with the repeal of Code Sec. 71, TCJA amended Code Sec. 152(d)(5) regarding the source of a qualifying relative's support. As previously mentioned, Code Sec. 152(d)(1)(C) requires that an individual receive more than one-half of his or her support from the taxpayer to be claimed as a qualifying relative of that taxpayer. TCJA provides, consistent with prior law, that payments of alimony or separate maintenance paid to a spouse or former spouse are not treated as support of a dependent provided by the payor spouse. However, TCJA revised the language of Code Sec. 152(d)(5) to eliminate references to Code Sec. 71 and Code Sec. 682, which were repealed by the TCJA.

In 2017, the IRS issued proposed regulations (REG-137604-07) providing rules regarding the definition of a dependent under Code Sec. 152, including a qualifying relative. The 2017 proposed regulations included references to repealed Code Sec. 71 and Code Sec. 682. In Notice 2018-70, the IRS announced its intent to issue proposed regulations providing that the reduction of the exemption amount to zero under Code Sec. 151(d)(5)(A) for tax years 2018 through 2025 will not be taken into account in determining whether an individual meets the requirement of Code Sec. 152(d)(1)(B) to be a qualifying relative.

Proposed Regulations

Last week, the IRS issued proposed regulations (REG-118997-19) which revise the 2017 proposed regulations by adding a paragraph to clarify the definition of a qualifying relative for tax years 2018 through 2025 and withdrawing and reproposing a rule in the 2017 proposed regulations regarding the support of a dependent under Code Sec. 152.

Consistent with Notice 2018-70, the newly-issued proposed regulations provide that in determining whether an individual is a qualifying relative for purposes of various provisions of the Code that refer to Code Sec. 152 in years in which the exemption amount is zero, the Code Sec. 151(d) exemption amount will be the inflation-adjusted Code Sec. 152(d)(1)(B) exemption amount in the annual revenue procedure setting forth inflation-adjusted items published in the Internal Revenue Bulletin.

Observation: The exemption amount is $4,150 for 2018 (Rev. Proc. 2017-58, modified and superseded by Rev. Proc.2018-18); $4,200 for 2019 (Rev. Proc. 2018-57); and $4,300 for 2020 (Rev. Proc. 2019-44).

According to the IRS, this interpretation accords with Code Sec. 151(d)(5), which suspends the deduction for a personal exemption or a dependency exemption without substantively changing other Code provisions that directly or indirectly reference the Code Sec. 151(d) exemption amount. The IRS also explained that this interpretation is confirmed by the structure of several Code provisions that necessitate a non-zero exemption amount in Code Sec. 152(d)(1)(B), including (1) the definition of a qualifying relative in Code Sec. 152(d)(1), (2) the new $500 credit under Code Sec. 24(h)(4), and (3) head of household filing status under Code Sec. 2(b)(1)(A).

The proposed regulations also withdraw Prop. Reg. Sec. 1.152-3(d)(2) of the 2017 proposed regulations and replace it with new Prop. Reg. Sec. 1.152-3(d)(2) to reflect the TCJA amendments to Code Sec. 152(d)(5) eliminating references to repealed Code Secs. 71 and 682. Finally, the proposed regulations clarify an issue raised regarding a cross reference in Code Sec. 24(h)(4) to "a qualifying child described in subsection (c)." The proposed regulations clarify that the cross reference is a reference to Code Sec. 24(c), rather than to Code Sec. 152(c).

Taxpayers are permitted to rely on the proposed regulations pending the issuance of the final regulations.

For additional discussion of claiming dependency exemptions, see Parker Tax ¶10,720. For a discussion of the child tax credit, see Parker Tax ¶100,701.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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