TAX SIMPLIFICATION RECOMMENDATIONS
Posted February 2001

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Family Status Issues, including the Earned Income Credit

Simplify and harmonize the definitions and qualification requirements associated with filing status, dependency exemptions, and credits. Complexity in family status issues arises because family status affects various tax provisions designed to accomplish different ends. As might be expected, the eligibility requirements are not identical – and the differences cause confusion and result in frequent tax return errors. The provisions are so complex and varied that we doubt that any amount of taxpayer education could ever eliminate the errors that inevitably occur.

Family status issues are further complicated by the increasing number of nontraditional families and living arrangements today, a phenomenon that cuts across all income levels but causes particular difficulty for low income taxpayers trying to prepare their returns. Divorced parents are much more common today than they were even 20 years ago. When both divorced parents or multiple generations provide some measure of assistance to the child, there are competing claims for tax benefits relating to that child.

On top of this, many tax benefits are unavailable to married taxpayers who file separately. This further complicates their tax filing decisions and tax calculations – and increases their combined tax liability over what it would be were they to file jointly.

Given the differing policy considerations underlying the family status provisions, it may not be possible to develop uniform definitions and achieve optimum simplicity. It is possible, however, to simplify and harmonize the eligibility criteria for many of the provisions and to establish safe harbor tests that provide taxpayers with more certainty and comfort. To that end, we recommend the following changes:

1. Create a safe harbor test for determining eligibility for the dependency exemption, head of household (HOH) status, earned income credit (EIC), child credit, and child and dependent care credit, permitting the custodial parent or guardian of a child to claim these tax benefits. This would lessen the intrusiveness of audits on eligible taxpayers while targeting cases of fraud or abuse. In most cases, custody can be demonstrated by court orders, separation agreements, or government or private agency placements. Retain the ability of the custodial parent or guardian to consent to transfer the dependency exemption to the noncustodial parent (or other third party).
    
2. Create a safe harbor test for the AGI tie-breaker rule under the EIC (IRC § 32(c)(1)(C)). Absent fraud, the custodial parent or guardian of a qualifying child would be deemed to maintain a separate principal place of abode with that child and would be eligible therefore to claim the EIC, regardless of what other adult also resides in that residence.
    
3. Modify the definition of "foster child" for five purposes: dependency exemption, HOH status, EIC, child credit, and child and dependent care credit. The revision would require foster children to live in the same principal place of abode with the taxpayer for more than one-half the year (as opposed to a full year under current law).
    
4. Define "earned income" for EIC purposes as taxable wages (Form 1040, Line 7) and self-employment income (Form 1040, Line 12, less Form 1040, Line 27).
    
5. Deny the EIC to taxpayers whose foreign earned income exceeds $2,200 (adjusted for inflation) or whose AGI exceeds earned income by more than $2,200 (adjusted for inflation), excluding taxable social security, pensions, and unemployment compensation (items easily taken from the face of the tax return).
    
6. Apply one standard for qualification as a dependent child and head of household status that combines support with the cost of maintaining a taxpayer’s household. Use the same terminology in each statute to refer to this expanded support concept.
    
7. Provide that certain government benefits (food stamps, Section VIII housing subsidy, payments under the Temporary Assistance to Needy Families program, child’s social security benefits) do not "count against" the custodial parent in determining "expanded support" for purposes of the dependency exemption, HOH, and the child and dependent care credit.
    
8. Repeal the Child Tax Credit (IRC § 24); replace it by increasing the amount of the dependency exemption and expanding the child and dependent care credit.
    
9. Establish a uniform credit rate for the child and dependent care credit; remove or adjust for inflation the limitation of dependent care expenses eligible for the credit; and make the credit refundable. Remove (or increase) the $5,000 limit (whether joint, HOH, or single) on dependent care expenses eligible for exclusion (pre-tax treatment by the employer).
    
10. Extend HOH status to noncustodial parents who can demonstrate their payment of more than nominal child support. This proposal acknowledges that children often have more than one household and that the noncustodial parent who pays child support has a reduced ability to pay tax. The benefit will be targeted primarily to those taxpayers who do not itemize deductions. The proposal also encourages the payment of child support and removes the incentive for fraud or noncompliance under other family status provisions.
     
11. Conform the treatment of married filing separately taxpayers under family status provisions to the treatment of similarly situated joint/single/head of household taxpayers, unless a clear, overriding policy reason exists for the different treatment.

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