Editor: Mark G. Cook, CPA, MBA
Issues surrounding citizenship in the United States have been the subject of a long-standing debate. Issues on citizenship are found across a wide range of subjects, especially in tax. With a more global economy, more U.S. citizens live outside the country. Many marry noncitizens and have children who have not yet filed for U.S. citizenship. U.S. citizens living outside of the country are still required to file annual income tax returns, and most look to dependent exemptions and credits to lower their tax liability. These tax benefits require a taxpayer’s dependent to be a U.S. citizen. However, issues can arise as to when the citizenship test of Sec. 152(b)(3)(A) must be satisfied to claim children as dependents. This is true in a recent case (Carlebach, 139 T.C. No. 1 (2012)), where taxpayers Leah M. Carlebach and Uriel Fried, who were living outside the United States, claimed dependency exemption deductions, the child care credit, child tax credit, and additional child tax credit.
The taxpayers have six children. Carlebach, the mother, is a U.S. citizen, and Fried, the father, was born in Israel and is not a U.S. citizen. The father and children have always lived in Israel. In June 2007, four of the children were granted U.S. citizenship. The other two children were granted citizenship in April 2008. In December 2007, the taxpayers filed their Forms 1040A, U.S. Individual Income Tax Return, for 2004, 2005, and 2006. The taxpayers claimed dependency exemption deductions, child care credits, and additional child tax credits from 2004 through 2007, claiming three of the children in 2004, four in 2005 and 2006, and all six in 2007.
The citizenship or residency test of Sec. 152(b)(3)(A) says that “[t]he term ‘dependent’ does not include an individual who is not a citizen or national of the United States unless such individual is a resident of the United States or a country contiguous to the United States.” Relevant to this discussion is Regs. Sec. 1.152-2(a)(1), which states that “to qualify as a dependent an individual must be a citizen or resident of the United States . . . at some time during the calendar year in which the taxable year of the taxpayer begins.”
The IRS argued that the taxpayers were not entitled to the dependency exemption deductions from 2004 through 2007. The IRS argued that because the children did not become citizens until they received their certificates of citizenship, none of the children met the citizenship test for 2004, 2005, or 2006, and only four met the citizenship test in 2007; hence, the taxpayers were not entitled to the dependency exemption deductions and child-related credits. The IRS assessed approximately $39,308 in total deficiencies, additions to tax, and penalties, which resulted from the incorrect dependency exemptions and related credits.
The taxpayers mainly contended that they were entitled to the dependency exemption deductions because their children were citizens at the time they filed their returns, claiming that Regs. Sec. 1.152-2(a)(1) is invalid. They argued that Sec. 152(b)(3)(A) is “unambiguous” in its requirement that the dependents only be citizens at the time the return is filed, stating the statute does not require citizenship for the tax year they were claimed as dependents. Thus, under the Supreme Court’s decision in Chevron U.S.A Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), the regulation could not impose a requirement that the children be citizens during the tax year for which the dependency exemption is claimed.
To further support their position, taxpayers also cited Russello , 464 U.S. 16 (1983), in which the Supreme Court stated: “[W]here Congress includes particular language in one section of a statute but omits it in another section of the same Act, it is generally presumed that Congress acts intentionally and purposely in the disparate inclusion or exclusion.” Because Congress expressly included the time requirement in other elements of Sec. 152, such as the principal place of abode, age, and support tests, the taxpayers argued that it had intentionally omitted a time requirement as part of the citizenship test.
Although the Tax Court agreed that the statute was arguably unambiguous, it disagreed with the taxpayers on its meaning. The court found that the “statute can only be read as being consistent with, not contrary to” Regs. Sec. 152(b)(3)(A), stating the taxpayers’ argument was not based on the statute’s true context, as “Congress did not intend section 152(b)(3)(A) to be read in a manner inconsistent with” Regs. Sec. 1.152-2(a)(1). According to the court, Sec. 152(b)(3)(A) must be interpreted in the context of subtitle A of the Internal Revenue Code.
The Tax Court explained that a system of annual accounting was embedded in federal income tax law and that “[g]enerally, a Federal income tax return reflects the events that affect income during the taxable year for which it is filed.” Consequently, it concluded that allowing the taxpayers to take the dependency exemptions and child credits for children who did not meet the citizenship test in Regs. Sec. 1.152-2(a)(1) would be violative of Congress’s expressed preference in the income tax provisions of the Code for a system of annual accounting.
Having found that the regulation was valid, the Tax Court concluded that, since none of the children satisfied the citizenship test for 2004 through 2006, and only four qualified for 2007, the claimed dependency exemptions for 2004 through 2006 were invalid and that only four of the exemptions for 2007 were valid.
This case demonstrates that dependents living abroad cannot be claimed as dependents until the year they become U.S. citizens. Therefore, for U.S. taxpayers living abroad, attaining U.S. citizenship for dependents is vital in qualifying for dependency exemption deductions and other dependent-related credits. As this case shows, the opportunity and actual costs can be significant for not doing so.
Mark Cook is a partner at SingerLewak LLP in Irvine, Calif.
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