While every year has its changes in terms of new and changed tax laws, the 2006 filing season presents a special challenge to the practitioner who prepares individual tax returns for 2005. From legislative changes to natural disasters, practitioners need to be at the top of their game to identify and address all of the changes that occurred in the past year.
On the December 2005 Webcast of Tax Talk Today, a panel of IRS officials and tax experts (including myself) discussed the most sweeping of those changes that will affect 2005 federal tax returns. Here are some highlights of that discussion.
The panel’s tax experts and the IRS agree that the new definition of a qualifying child is the most significant change impacting 2005 individual tax returns. These changes can affect up to five different tax benefits for an individual, including head of household filing status, dependency exemptions, the child tax credit, the child and dependent care credit, and the earned income credit.
According to the new definition, there are now four tests to identify a qualifying child:
Relationship: Is the child the taxpayer’s child, sibling, or a descendant of the taxpayer’s child or sibling?
Residency: Did the child live with the taxpayer for more than half of the tax year?
Age: Is the child younger than 19 years of age, or younger than 24 if a student, or permanently and totally disabled?
Support: Did the child provide no more than half of his or her own support for the year?
As with any tax law, there are some exceptions and additional requirements for the different tax benefits associated with the qualifying child, but this set of tests applies most of the time. If more than one person claims the same qualifying child, the old earned income credit tie-breaker rules are now used across the board to determine who is a qualifying child for any of these benefits: Filing Status, Dependency Exemptions, Child Tax Credit, Child and Dependent Care Credit, and Earned Income Tax Credit. Special rules apply for the dependency exemption and child tax credit if the parents are divorced or separated.
Because the new definition of a qualifying child affects so many benefits, tax practitioners really cannot use last year’s return as a solid base for developing this year’s return. In particular, tax experts expect to see big changes in head of household status as the new rules impact who does and does not qualify as a dependent.
“We’re going to see some head of household statuses lost this year,” said panelist David Morley, a CPA and president of Morley & Associates in Enid, Oklahoma. “You just can’t assume that what you claimed last year–that dependent–you’re going to be able to claim this year.”
Tax practitioners must approach the issue in two tiers: Determine whether you have a qualifying child and, if yes, then you can stop there. However, if the situation in question does not meet the requirements for a qualifying child, then it is time to examine the rules for a qualifying relative in order to determine the dependency exemption.
In a related area, the definition of a foster child has changed as well. In order to qualify, the child must have either been placed by an authorized placement agency, by order of a court of competent jurisdiction, or by a judgment of that court. The child must have lived with the taxpayer for more than half of the year, which is an improvement over the previous full-year residency requirement for foster children.
“That will put them on par with other children,” said another panelist, Robert Erickson, senior technical advisor, tax forms and publications, with the IRS.