NEW DEFINITION OF DEPENDENT
Prepared by: Debra L. Mackey, Esq.
Burr & Forman LLP
Birmingham, AL
The Working Families Tax Relief Act of 2004 (WFTRA), enacted on October 4, 2004, amended the definition of “dependent” found in Internal Revenue Code Section 152, effective for tax years beginning after 2004. This definition is cross referenced for many purposes under the Internal Revenue Code (e.g., dependent care credit, earned income credit, personal exemption), and is often used by many employee benefit plans to determine who may be covered by the plan as a “dependent.” Certain persons who qualify as dependents under current law may not qualify as a dependent after 2004. Under amended Code Section 152, a dependent means a “qualifying child” or a “qualifying relative.” For purposes of simplification, the following discussion assumes that the taxpayer's taxable year is the calendar year.
A “qualifying child” is an individual who meets each of the following four criteria: (1) is the taxpayer’s child, brother, sister, stepbrother, stepsister or a descendent of any of these persons; (2) has the same principal place of abode as the taxpayer for more than half of the year; (3) is under age 19 or is a student under age 24; and (4) has not provided over half of his own support for the year. If the individual is permanently and totally disabled at any time during the year, he is deemed to meet the age requirement (criteria (3)). “Child” means the taxpayer’s son, daughter, stepson, stepdaughter, or eligible foster child. “Student” means an individual who during five months of the year is a full time student at an educational organization or pursuing a full time course of institutional on-farm training.
It is not unusual for more than one taxpayer to desire to claim a child as his dependent. The new definition contains ordering rules for this purpose. Between a parent and a non-parent, the parent wins. Between two non-parents, the one with the highest adjusted gross income wins. Between two parents, the one with whom the child resided the longest during the year wins unless the child resides with both parents for exactly the same time. In that case, the parent with the highest adjusted gross income wins. These are new rules. A separate special rule applies for divorced parents (including those legally separated, separated under a written separation agreement, or living apart at all times during the last six months of the calendar year). This rule is very similar to current law. If a child receives over half of his support during the calendar year from his parents, and the child is in the custody of one or both parents for more than half of the year, the non-custodial parent wins if the decree/agreement provides that the non-custodial parent is entitled to the dependent deduction, the custodial parent signs a written declaration that he will not claim the child as a dependent, or the non-custodial parent provides at least $600 in support for the year under a pre-1985 agreement. Otherwise, the custodial parent wins.
A “qualifying relative” is an individual who meets each of the following four criteria: (1) is the taxpayer’s child (or a descendent of his child), brother, sister, stepbrother, stepsister, father or mother or ancestor of either, stepfather, stepmother, niece, nephew, aunt, uncle, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, sister-in-law, or an individual (other than one who was the taxpayer’s spouse at any time during the year determined without regard to Code Section 7703) who has the same principal place of abode as the taxpayer and who is also a member of the taxpayer’s household; (2) has gross income for the year less than the exemption amount ($3,100 for 2004); (3) receives over half of his support from the taxpayer; and (4) is not a qualifying child of the taxpayer or of any other taxpayer. Note that an individual can’t be a member of the taxpayer’s household if at any time during the year the relationship between the individual and the taxpayer violates local law. This is the current rule as well.
There are ordering rules where the individual receives support from multiple taxpayers, also retained from current law. If no one taxpayer contributes over half of the support, but over half was received from two or more persons, each of whom would have been entitled to claim the individual as a dependent but for meeting the support criteria, a taxpayer who provides over ten percent (10%) of the individual’s support may claim the person as a dependent if each other person who contributed over 10% of the support files a written declaration that they will not claim the person as a dependent.
Note that when dealing with a handicapped person, income attributable to services performed at a sheltered workshop is not included as income if the availability of medical care at the workshop is the principle reason for being there and the income arises solely from activities that are incident to such medical care. A sheltered workshop is a school providing special instruction or training designed to alleviate the disability that is operated by a 501(c)(3) organization or a governmental entity.
The current definition of dependent limits the individuals who may be a dependent to those persons named in the “relationship” criteria for a qualifying relative. Additionally, current law requires that such persons receive over half of their support from the taxpayer in order to be a dependent. Unlike the new law, current law does not impose any age or income limits for dependent status. (Recall the age limits for a qualifying child and the income limit for a qualifying relative, discussed above.)
Any employee benefit plan under which status as a dependent is important should be reviewed to determine how dependent is defined. If dependent is defined by reference to Code Section 152, the plan sponsor should carefully review the effect the new definition will have on the plan. Of particular concern are the age limits imposed for dependent child status since most health plans impose an age limit on the eligibility of children and students. If the plan's limits differ from the age limits found in the new law, plans will have to be amended to conform to the new law in order to retain the exclusion from income of the plan coverage and benefits. A related concern arises when a student reaches age 24 because he is no longer a qualifying child. In order to remain a dependent, he must qualify as a qualifying relative. Income from a summer job, for example, may be sufficient to cause such an individual to fail to meet the income criteria, thereby fail to qualify as a dependent. Fortunately, the special rule discussed below ameliorates this issue as applied to a health plan governed by Code Sections 105 and 106.
In Notice 2004-79, the Internal Revenue Service states its belief that Congress intended to maintain the “old” definition of dependent for purposes of employer provided health plans. Despite the new definition, WFTRA directly amended Code Section 105 so that certain exceptions from dependent status under the new dependent definition will not apply. These exceptions are the non-recognition of dependent status of (i) a person who is a dependent of a dependent, (ii) a married person who filed a joint tax return, and (iii) the gross income limit on a qualifying relative. This means that a person who falls into one of these three categories will not fail to qualify as a dependent under a health plan if they otherwise meet the applicable criteria. The Internal Revenue Service also stated that it will issue conforming regulations under Section 106 so that the same definition of dependent will apply to both Code Sections 105 and 106. Other benefits that are directly affected by the new definition are: legal service plans, dependent care assistance plans, and fringe benefit plans.
Return to the Legislative Updates page.