It’s the most wonderful time of the year! Yes, once again it is time to gather all your most intimate financial information, including a list of persons in your household, so you can file your personal income tax return and hope that, after remembering to cross your ‘i’s and dot your‘t’s, you’ll avoid the audit flags raised by falling outside the ‘usual and customary parameters’ as defined by our favorite branch of the government, the Internal Revenue Service.
New for tax year 2007, the IRS has made it perfectly clear that if you support someone who lives in your household for the whole year and who is NOT related to you by blood or marriage AND you support that person’s child, you can put BOTH your friend and the child on your tax return as a ‘Qualifying Relative Other’ for exemption purposes, reducing your taxable income and tax liability.
Every year the IRS changes, deletes and clarifies codes, definitions and rules. The classification of ‘Qualifying Relative’ (QR) has been modified and clarified since 2005 and you and your tax preparer may not be aware of how this affects you. It sounds much more intimidating than it is, but the IRS recently issued a ruling which makes logical sense. Mirabile dictu!
For income tax purposes, a Dependent is a person who is supported by you. The IRS has very exact rules to follow for the definition of Dependent which vary a bit when looking at (HOH) filling status. The definition of Dependent for Exemption purposes was refined in 2005, but the notes issued on the definition did not exactly match the actual intent of Congress, which the IRS enforces.
On Jan 14, 2008, the IRS released a notice correcting the notes previously issued. In IRS Publ. 17, pages 22 to 34, and again in Publ. 501, pages 9 to 14, the rules for Dependent: Qualifying Relative (QR) are redefined to be clearer and less ambiguous. A QR is related by blood or marriage, lives with you, is supported by you and is not claimed by any other taxpayer and may also qualify you for HOH filing status. However, a person can be a Qualifying Relative Other (QRO) for exemption purposes only if the person lives in your household for the entire year and is supported by you. So you could claim your boy/girlfriend. But if they had a child, you couldn’t claim the child. Prior to the IRS Notice of Jan 14, 2008, a child could not be claimed as a QRO if there was anyone else who could possibly legally claim the child even if they did not do so. The child’s exemption was lost.
John Wood, CPA, noted that, “the IRS has changed the wording in Pub. 17 Table 3-1 for 2007. [The test for] “Qualifying Relative” now reads “the person cannot be your qualifying child or the qualifying child of any other taxpayer”. [In prior years, it read] anyone else.”
“Many people, including tax professionals, may have incorrectly interpreted the law and may have overlooked or failed to properly claim a dependent exemption. The IRS issued Notice 2008-5 on January 14, 2008 in an attempt to clarify the meaning of a qualifying relative. Congress has not changed the law and the IRS notice does not reflect a change in its interpretation of the law. It is a “clarification”, and it is applicable to all tax years after 2004. [i.e. 2005, 2006, 2007 etc] This means that taxpayers, who were told, based on a widespread misinterpretation that they could not claim an unrelated person, may be able to file an amended return to claim the dependent exemption.”
In 2005 and 2006, a taxpayer could claim a person who was NOT related by blood or marriage as a dependent for the personal exemption only. This meant if your boyfriend, girlfriend or other person lived with you for the whole year and was supported by you, then you could include him/her on your tax return as QRO and take the personal exemption. The stickiness was if your QRO had a child, many tax professionals and tax software packages would not allow you to claim the child even if you supported the child, because of the phrase “any other person,” erring on the side of caution. If this situation applies to you, as Mr. Wood states above you may want to file an amended return for tax years 2005 and/or 2006.
For filing year 2007, if you can claim the parent and no one else (i.e., former spouse, biological parent) claims the child, then you can use the child’s personal exemption. It makes perfect sense. If Richard Roe and his daughter, Rachel Roe, live with you all year and you provide all their support, then you can put both of them on your tax return as QRO and take both personal exemptions.
Each personal exemption reduces your taxable income by $3,400 for the 2007 tax year. Depending on your particular situation, this can result in a significant reduction in your actual tax liability. For example: Sally Smith makes $25,000 per year. She supported her boyfriend, Richard Roe and Richard’s minor daughter Rachel for the whole year. Her filing status is Single with 3 exemptions.
Her standard deduction of $5,350 and three exemptions total $10,200. This makes her taxable income $9,450, and her tax liability is $1,030. Before these changes went into effect, Sally would have been Single with 1 exemption, herself. Her taxable income would be $16,250 and the tax on that is $2,050. Being allowed to claim the exemptions for Richard and Rachel reduces her tax burden by $1,020.
Mr. Wood also pointed out that while that “a child who ‘ages out’ of Qualifying Child status may still be considered the taxpayer’s dependent, as long as he or she meets the requirements for a Qualifying Relative. Therefore, provided the individual meets the new requirements, a taxpayer’s 24 year-old child could be a dependent.”
NTNN would like to thank Mr. Wood for his valuable input, knowledge, research and the time he spent assisting in the preparation of this article.
For more information or clarification, contact John S. Wood, CPA, at www.jwoodcpa.com or your tax professional. The IRS can be reached on-line at www.irs.gov or call the 1-800-829-1040 helpline.
Published in NTNN on February 8, 2008. Vol 16, issue 3.