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Tax Law Notes Legal Issues, Governance, and the IMF
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Tax Law Note: How Might the Law Define a Dependent of the Taxpayer? Legal Department Last Updated: December 02, 2004 Introduction Most income tax systems provide relief to taxpayers supporting other persons (dependents), usually in the form of deductions, or credits. In countries offering such relief, it is typically taken into account in withholding from wages and therefore applies regardless of whether the taxpayer files an income tax return. Ideally, "dependent" should be defined so that the tax benefit does not reach taxpayers who should not receive tax relief and reaches all taxpayers who deserve relief. This note does not consider whether dependent relief should be provided or the structure of that relief, but focuses on the problem of defining dependents eligible for relief. Defining dependents involves the following issues:
Country Practices 1. Relationship Some countries require dependents to be relatives; others do not2. 2. Age Countries generally impose an age limit for children to be considered as supported. The limit is usually 18 years and up to 24-25 years if the child is a full-time student.3 3. Residency test4 In most countries a certain circle of related family members are presumed to be supported by the taxpayer (e.g. children under the age of 18) while for the rest of the relatives/other persons the test for being considered as supported is whether or not such person lives in the same household as the supporter taxpayer in a given tax year.5 Some countries also require that the supported person be a resident of the same country.6 4. Allocation Sometimes more than one taxpayer satisfies the requirements for qualifying for tax relief for a particular dependent. This would be a case for example if a parent and a grandparent living in the same household could claim the tax benefit based on supporting the grandchild/child. Very few countries have allocation rules for cases where more than one taxpayer is entitled for dependency tax relief. Some countries automatically give the right to the tax relief to the higher income taxpayer.7 In the case of minor children, relief could also be allocated preferentially to the parents. 5. Support Many countries require taxpayers to provide a certain percentage of all the support of the dependent person in order to qualify for the tax relief.8 6. Minimum income Dependency is often not recognized if the supported person receives income which is above a certain threshold.9 Fashioning a Solution Defining dependents eligible for relief is a difficult exercise which requires an understanding of family structures as well as the practicalities of tax administration. Most countries will choose simple and easily administrable tests. More sophisticated requirements, while having theoretical justification as a matter of tax equity, might be unenforceable and unduly complex in practice, and hence should be avoided unless the tax administration is quite sophisticated. An example is a limitation based on the dependent's own income. In principle, if a dependent has enough income for their own support, no relief should be given to the parent. However, it might be difficult in practice for the parent to determine how much income their child in fact earned. Moreover, the tax authorities might not be in a position to audit compliance with this requirement. In this case, it might be preferable to omit from the definition of qualifying dependent any reference to the dependent's income, so that the definition can work well in practice. (Alternatively, the income limit might be applied only in certain cases, such as that of dependents who do not live in the taxpayer's household.) It can generally be presumed that the children of the taxpayer below a certain age10 are supported by the taxpayer; however, the taxpayer may also support others. Limiting dependents to relatives would be underinclusive, but administratively easier to control. If dependents are not limited to relatives, or if relatives are defined broadly, then other more complex tests, such as the support test and the residency test, may be required. The residency test is simpler than the support test, but not without complexity. Usually a dependent will live in a single household for more than half of the year, but provision should be made where this is not the case. Temporary absences (e.g. staying at a boarding school) should also be covered by the definition of residency. While the support test may seem simple at first glance, it is in practice quite complex in cases where the dependent receives support from more than one source, particularly as much support is given in kind.11 Because of this complexity, it is preferable to limit the situations where the support test must be applied, or avoid it altogether. There should also be clear rules with respect to who may claim tax relief if there is more than one qualifying taxpayer. One solution would be based on relationship, say for example that a mother or a father is given preferential right to the tax benefit over an uncle.12 Giving the tax relief to the person providing the most support may result in a more just situation, but may not be administratively feasible. Alternatively the higher income taxpayer among those satisfying the criteria for relief may be given priority - this is likely lead to the most favorable (for the taxpayer) use of the tax benefit in a system with progressive income tax rates. Or the taxpayers in question may be allowed to assign eligibility for the relief to one among them by mutual agreement. For Further Reference Lee Burns and Richard Krever, Ch. 14: Individual Income Tax, in 2 Tax Law Design and Drafting,. 542 - 546 (V. Thuronyi ed., IMF: 1998) Deborah H. Schenk: Old Wine in Old Bottles: Simplification of Family Status Tax Issues, Special Supplement, Tax Notes 1437 (May 28, 2001) The series of Tax Law Notes has been prepared by the IMF staff as a resource for use by government officials and members of the public. The notes have not been considered by the IMF Executive Board and, hence, should not be reported or described as representing the views of the IMF or IMF policy. 1Lee Burns and Richard Krever, Ch. 14: Individual Income Tax, in 2 Tax Law Design and Drafting,. 542 - 546 (V. Thuronyi ed., IMF 1998) ("TLDD"). 2The U.S. requires the dependent to be a relative (either lineal descendants or ancestors, sisters, brothers or their descendants, in-laws or adopted children) or if the individual is not a dependent (e.g. foster child) should be member of the taxpayer's household for the entire year. IRC sec. 152 (a), Germany and the Netherlands include relief for foster children. EStG §32, Wet IB § 6.13. See TLDD, supra note 1, at 546. 3The applicable limit used in the U.S. for certain tax relief purposes is 13 years, for others 17 years, and again for different benefits 19 (or 24 if a full-time student). Deborah H. Schenk: Old Wine in Old Bottles: Simplification of Family Status Tax Issues, Tax Notes, Special Supplement, p. 1437 (May 28, 2001). In the Netherlands tax relief may be credited until the child is 30 if he or she is substantially supported. Wet IB Art. 6.13. France considers children as supported until the age of 18 or without an age limit if they are ill or live in the same household. CGI Art. 196. 4The term residency test is used throughout this document as meaning whether or not the supported person resides in the same household as the taxpayer. 5In France children under 18 and handicapped children are deemed to be supported while other children are only regarded as supported if they share the same household. CGI 196 In the U.S. an individual who is not related to the taxpayer may qualify as a dependent if he or she is a member of the taxpayer's household for the entire tax year. Temporary absences are ignored (e.g. illness, school, military service). IRC sec. 152 (a). 6The U.S. requires dependent persons to be citizens/residents/nationals of the U.S., Canada or Mexico. I.R.C. sec. 152 (b)(3). In Australia dependents need to be residents of the country. ITAA 1936 sec. 159J. 7For example in Belgium and the Netherlands the tax deduction is allocated to the higher income spouse. In Sweden the benefit is paid to the mother if she is in charge of the child. TLDD, supra note 1, at 546. In Cyprus the tax allowance is apportioned between the spouses according to the net income of each spouse. European Tax Handbook 137 (IBFD 2001). 8In Australia the taxpayer actually has to contribute to the maintenance of the child or student in order to qualify for a tax relief. ITAA 1936 sec.159J. In the U.S., the taxpayer is required to provide more than half of the support of the individual (taking into account all sources of income of the individual). I.R.C. sec. 152(a). In the Netherlands a child is regarded as provided substantial support (which is the condition for the dependency tax relief) if more than half of his or her total support comes from the taxpayer. Wet IB Art. 6.13. 9TLDD, supra note 1, at 546. In the U.S. if the child has gross income equal to or in excess of the tax relief to be provided to the taxpayer, the taxpayer does not qualify. I.R.C. sec. 151 (c). 10The simplest approach administratively would be to look to the dependent's age as of Jan. 1 (assuming the tax year is on a calendar year basis). This means that availability for relief is delayed in the case of newly born children, but a compensating amount of relief is provided in the year in which the child exceeds the age limit. Basing the information as of the situation at the beginning of the year is simpler because it requires the taxpayer to inform the employer about information needed to calculate withholding once a year only. 11Debora H. Schenk Id. 12Id.
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