Life has been pretty good these past few weeks, dear readers. There have been moments, however, when life takes an unexpected turn. The latest turn it has taken has me switching from my “Paul on Vacation” hat to my “Paul the Tax Accountant” hat!
It caught me by surprise, but after taking a few minutes to think things out, I can see why my “Tax Hat” is getting a bit more use. The current economic conditions in general and the upcoming implementation of some new U.S. income tax regulations in particular have taxpayers abuzz. The chatter about possible tax increases and how to legally minimize their effects has significantly increased.
CHATTER FROM EXPATS IN THE PHILIPPINES
U.S. taxpayers living in the Philippines are very much among those with questions. I’ve received a number of private e-mails from some of those taxpayers. Additionally, as a member of various Philippines-oriented chat groups and forums, I read and respond to these tax questions.
A vast majority of these questions deal with the same topic. In an effort to make sure that only the legal minimum income taxes are assessed and paid, these taxpayers are looking at their families and, in particular, whether they are claiming all of the exemptions for dependents that they are legally entitled to claim.
Handling these questions has become a labor of love for me. Taking care of those received via e-mail is rather easy. After all, not only have I been trained in these tax matters, I also have over fifteen years of experience to call on. The questions posed in the chat groups and forums, however, are a different story.
As those of you who are members of chat groups and forums know, a question posted to the group or forum will net a number of responses – some that are valid and correct, but far too many that are based on misconceptions, rumors, “SWAGs” (Scientific Wild A** Guesses), or other invalid or incorrect information. All answers are well-intentioned but, when it comes to U.S. income tax matters, they can be downright harmful.
WHAT’S THE BIG QUESTION?
Summarizing and paraphrasing, the BIG question is:
“Can I claim an exemption for my Philippine children as dependent?”
Like almost all questions dealing with the provisions of the Internal Revenue Code (IRC), the answer is a resounding, “Maybe.” Whether the answer is “Yes” or “No” depends on the circumstances surrounding the taxpayer, the taxpayer’s family situation, and family members’ citizenship and residency status, among other things.
For the most part, the U.S. taxpayers who are asking the BIG question are U.S. citizens living in the Philippines who married Philippine citizens with Philippine citizen children. They consider the children as dependents, having paid all living expenses that those children incur.
They know that to claim any exemptions, the children would need either a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN). They also know that an SSN can only be issued to a U.S. citizen or a U.S. resident alien (i.e., a “Green Card” holder). So, they correctly deduce that the children may need ITINs.
WHO IS ELIGIBLE FOR AN ITIN?
According to the Internal Revenue Service (IRS), the IRS “issues ITINs to foreign nationals and others who have federal tax reporting or filing requirements and do not qualify for SSNs. A non-resident alien individual not eligible for a SSN who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty needs an ITIN.
“Additionally, examples of individuals who need ITINs include:
- A nonresident alien required to file a U.S. tax return,
- A U.S. resident alien (based on days present in the United States) filing a U.S. tax return,
- A dependent or spouse of a U.S. citizen/resident alien, and
- A dependent or spouse of a nonresident alien visa holder.”
That third example, “A dependent or spouse of a U.S. citizen/resident alien,” sounds like a lock, doesn’t it? That’s what many of those asking the BIG question think. They believe that those children are eligible for an ITIN and, with an ITIN, they can claim an exemption for their dependent children. In most cases, THEY ARE WRONG.
WHO IS A DEPENDENT?
The example above refers to being a dependent – that’s the operative word: “dependent.” The IRS has its own definition for the word, “dependent,” and it is that definition that must be used for U.S. income tax purposes.
On the surface, the definition appears simple. The IRS says that a dependent is either a “qualified child” or a “qualified relative.” There are five “tests” that must be met for someone to be deemed a “qualifying child” or a “qualifying relative.” Almost all who ask the BIG QUESTION have children who meet the five tests for being a “qualifying child.”
The major problem that arises, though, is with the actual claiming the exemption on the taxpayer’s tax return. Not all dependents can be claimed as an exemption. You can claim an exemption for a “qualifying child” or “qualifying relative” only if these three tests are met.
- Dependent taxpayer test.
- Joint return test.
- Citizen or resident test.
The Philippine citizen children of U.S. citizens living in the Philippines almost always meet the first two tests. Big problems occur with the third one – the citizen or resident test.
CITIZEN OR RESIDENT?
Here, again, is what the IRS says about this test: “You generally cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico. However, there is an exception for certain adopted children.
If you are a U.S. citizen or U.S. national who has legally adopted a child who is not a U.S. citizen, U.S. resident alien, or U.S. national, this test is met if the child lived with you as a member of your household all year. This exception also applies if the child was lawfully placed with you for legal adoption.
So, finally, we are finding an answer to our BIG QUESTION. You can claim an exemption for a “qualified child” if the child is:
- A U.S. citizen,
- A U.S. resident alien,
- A U.S. national,
- A resident of Canada or Mexico,
- A child who is not a U.S. citizen, U.S. resident alien, or U.S. national but is legally adopted by a U.S. citizen or a U.S. national, who lived with the taxpayer as a member of the taxpayer’s household all year, or
- A child who is not a U.S. citizen, U.S. resident alien, or U.S. national but was legally placed in foster care with a U.S. citizen or a U.S. national, who lived with the taxpayer as a member of the taxpayer’s household all year
For a U.S. taxpayer to claim an exemption for a dependent Philippine citizen child on that taxpayer’s tax return, that child must be either legally adopted by, or be legally placed in foster care with, the U.S. taxpayer. Said child would be eligible for an ITIN unless the adopted child becomes a U.S. citizen, wherein the adopted child would be eligible for a SSN.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction(s) or tax-related matter(s) addressed herein.