Tax Court upholds regulation requiring dependents be citizens in year tax benefits are claimed

On Thursday, the Tax Court upheld Regs. Sec. 1.152(a)(1), which requires that children be U.S. citizens at some time during the calendar year for which the children are claimed as dependents, as a valid interpretation of Sec. 152(b)(3)(A) (Carlebach, 139 T.C. No. 1 (2012)).

The taxpayers and their six children resided in Israel. The mother was a U.S. citizen; the father was a citizen of Israel and had never resided in the United States. The six children were born and always lived in Israel. In 2007, four of the children were granted U.S. citizenship, and in 2008 the other two became U.S. citizens. In December 2007, the taxpayers filed U.S. individual tax returns for 2004, 2005, and 2006, claiming dependency exemptions, child tax credits, and an additional child tax credit and reporting overpayment of tax.

After paying the claimed refunds for those years, the IRS reconsidered, and determined deficiencies, additions to tax, and penalties for each year. The IRS concluded that the taxpayers were not entitled to the claimed deductions and credits because the children were not U.S. citizens during the tax years at issue.

Sec. 152(b)(3)(A) says, “[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.” Regs. Sec. 1.152-2(a)(1) clarifies this by requiring, “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” (emphasis added).

The taxpayers argued that the statute, which does not mention a time requirement, requires only that children be citizens at the time the return is filed and unambiguously does not require that they be citizens at any time during the tax year  in which they are claimed as dependents. They further argued that because the statute is unambiguous on this point, the temporal requirement in the regulation interpreting the statute is not permitted, under the doctrine of Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 867 (1984). They also argued that, because the children derived their residency status from their mother’s citizenship, they were citizens retroactively.

Derivative citizenship, the Tax Court explained, refers to citizenship that is obtained by virtue of a parent’s or grandparent’s citizenship status. In this case, the dependents were all born in Israel, but their mother was a U.S. citizen, and they obtained their citizenship under 8 U.S.C. Section 1433, which allows applicants to apply from abroad, but requires them to swear an oath of allegiance while they are within the United States before they receive a certificate of citizenship. The six children became citizens under this method. The court held that under this procedure, while they derived their citizenship from their mother’s and grandparents’ status as U.S. citizens, they did not become citizens until they received their certificates of citizenship in 2007 and 2008.

Applying the Chevron analysis, the taxpayers argued that Congress’s omission of a time requirement in Sec. 152(b)(3)(A) was deliberate because Congress included a time requirement in several other sections of the dependency definition, such as the place of abode, age, and support tests, all of which had to be met within the tax year at issue.

The Tax Court, however, while agreeing that the statute was “arguably unambiguous,” said that the taxpayers had erred in not reading the statute in its true context, subtitle A of the Code, “in which the concept of an annual accounting system is deeply embedded.” This concept means that a federal income tax return reflects events that occurred during the tax year for which it is filed, which in this case means the years before the children became citizens.

The court also held that even if the statute were ambiguous, the regulation would still survive under part two of a Chevron analysis because the IRS’s interpretation of the statute was reasonable in light of the Code’s emphasis on a system of annual accounting. Finally, the court noted that the citizenship time requirement has been in the regulations since 1944, which adds further weight to its legitimacy.  

The Tax Court also denied the mother’s attempt to claim a dependent care credit for 2008 because she filed separately, and a joint return is required to claim the credit, and upheld accuracy-related penalties for negligence in filing a return claiming the dependency exemption in clear violation of a regulation.

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.