This transcript has been edited for clarity.

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: TCJA sunsets — improving personal exemptions.

As we've covered in previous episodes, a number of Tax Cuts and Jobs Act provisions are scheduled to expire at the end of 2025. How best to renew these provisions, if at all, will be a major concern of the next Congress. However, this week we're focusing less on the monetary issues related to renewing the provisions and more on potentially fixing what our guest deems as a "tax wrong" when it comes to the personal exemption and overseas dependence.

Here to talk more about this is Tax Notes contributing editor Robert Goulder. Bob, welcome back to the podcast.

Robert Goulder: Hello, Dave. Thanks for having me.

David D. Stewart: To begin, could you give listeners some background on the personal exemption?

Robert Goulder: You might recall in the old days, that's before the TCJA, the tax code permitted two major offsets against a person's adjusted gross income. These were first the standard deduction or the opportunity to claim an itemized deduction instead. And second, the personal exemption. Now, a key feature of the personal exemption was that it extended to your dependents. So let's say if you claim dependents on your tax return, that is, in addition to yourself, you were permitted to claim a corresponding multiple of the personal exemption amount as your return moved from adjusted gross income onto taxable income. Again, this was before the TCJA came along.

Looking at that system, the personal exemption was a very effective tool for lessening the tax burden on households with lots of dependents. But then the question would come up, well gosh, what if the dependents happen to live overseas? Can a non-U.S. resident qualify as a dependent for purposes of the personal exemption? And that's where the story gets interesting.

David D. Stewart: All right. Now, I understand you talked with someone about this. Who'd you talk to?

Robert Goulder: Yes, I spoke with Sarah Lora. She is an associate clinical professor of law at the Lewis & Clark Law School in Portland, Oregon. And she also serves as director of the Lewis & Clark Low Income Taxpayer Clinic.

David D. Stewart: And what did you talk about?

Robert Goulder: We discussed her recent publication, "Righting Tax Wrongs for Immigrants," which appeared in the Pittsburgh Tax Review earlier this year.

David D. Stewart: All right, let's go to that interview.

Robert Goulder: Sarah, welcome to the podcast. Now, before we get into the details of what the TCJA did to the personal exception, let's briefly review what the pre-TCJA framework looked like. I've alluded to these circumstances of taxpayers with nonresident dependents. Tell us, were such individuals eligible for purposes of the personal exemption?

Sarah Lora: Yes, they were and they still are. The only change that happened with the TCJA is that the personal exemption amount was zero. Prior to the TCJA, the personal exemptions were available for taxpayers living in the United States and their spouse and dependents living in the United States or in countries contiguous to the United States, generally that means Canada and Mexico.

There was a decrease in taxable income for each of those people, which was approximately $4,000 per dependent. But as you know, the TCJA changed that. They did not change the fundamental framework of the personal exemptions to the extent that we still have personal exemptions available for people who are in the United States and countries contiguous; they chopped out the exemption amount. So it's an important distinction because it has ripple effects as it goes along and it makes it slightly easier to fix as we go along and makes it seem like it may have been unintentional, the ripple effects that it had on these communities.

Robert Goulder: OK, so if I'm thinking about my tax return and I'm trying to get from adjusted gross income to taxable income, and TCJA comes along and it does things to the standard deduction, and then you've just described what it does with the personal exemption, there's this other thing it created called the ODC, the other dependent credit. Can you tell us a little about that?

Sarah Lora: Yes. So after the Tax Cuts and Jobs Act was enacted, they reduced the personal exemption amount to zero, but they offset that with several changes, including practically doubling the standard deduction, doubling the child tax credit and introducing a new credit called the ODC — the other dependent credit — which is a nonrefundable, itty-bitty $500 credit per dependent exemption on the return. So that was the trade-off. They said, "Yeah, we're getting rid of the personal exemption amount of $4,000 per dependent, but we're going to do these other things to try to offset that problem." And also, rightly so, boost the child tax credit and boost the standard deduction to make it more significant. In my opinion, rightly so, I should say.

Robert Goulder: Now, here's my big problem. What was the policy objective for imposing a geographical restriction on the ODC accomplished through this code section 24(h)(4)(B)? Now, I get that Congress wanted to keep this credit relatively small. I think you just described it as an itty-bitty provision and they made it nonrefundable, but why drop the language about contiguous countries? They did that on purpose. Were they just being mean? What was going on?

Sarah Lora: I think that they were copying the language from the child tax credit. It is word for word the same exact provision that you find two paragraphs up in the child tax credit. They just copied and pasted that language down and didn't really consider the ramifications of it. I honestly believe it was a mistake and just a copying error without real thought. I thought it was unintentional. I have found no congressional record describing the want of punishing families who have dependents in Canada and Mexico. And I think another point in that direction is that they did not change the fundamental structure of the dependent exemption. They did not change the country contiguous language.

What I see is just a copy and paste of the child tax credit, not realizing that while some may say, "Yes, we want to exclude dependents living in Mexico and Canada from the child tax credit," because it is a refundable credit because there are concerns with fraud and fraud in the ITIN (individual taxpayer identification numbers), which we'll get into later, but that really, because this is a nonrefundable credit, because we have the PATH Act in place preventing a lot of fraud in the first place that I think it's a very simple fix for us to remove that paragraph and then we will be back pretty similar to where we were with respect to dependence in Canada and Mexico prior to the Tax Cuts and Jobs Act. It's not perfect. It's not going to solve all the problems, but it's going to solve a lot of the problems and a lot of the heartache for these families.

Robert Goulder: Now, there are consequences to this. One is that the IRS won't necessarily be issuing individual tax identification numbers to nonresident dependents. In theory, there's no reason for them to do that if they're not eligible under the ODC. And if the personal exemption amount is zero, you could say, "All right, we just don't need to issue those numbers." But your article mentions that this hurts families. Could you elaborate on that?

Sarah Lora: So one of the consequences of reducing the dependent exemption amount to zero and excluding from the ODC dependence in Canada and Mexico was that there was a policy change in the ITIN unit. They said there's no allowable tax benefit. The IRS unit made up language and a requirement called allowable tax benefit. So they said if there's no allowable tax benefit, and what I realized what allowable tax benefit means is monetary tax benefit, then we're not going to issue the ITIN in the first place.

So I always, with my students, I have this map, it's almost like a timeline of tax events. At the beginning, we file the tax return and then there's preassessment disagreements about how much tax is owed. There's the whole deficiency procedures, and then we get assessment and then we go into CDP and we go into collections after that. We are stuck behind filing the return. We can't even get to the point where we can get the number to put on the return to file the return. So it's just that this family that's trying to count all the dependents that are allowed under the tax code cannot do so.

So this affects, what I call, is the correct family size. And the ripple effect of that is that they cannot claim student financial aid. They have problems with immigration-related applications, Medicaid. And then also I found, I can't remember, it's 14 or 17 states follow the language of dependent exemption to calculate their own dependent exemptions in the state tax system. And so if those people aren't on the return, they will be getting incorrect state tax information as well for the purposes of their state taxes. So accurate family size counts are essential for all of these programs.

And then what we also found is that collections with the IRS also depend on correct family size. So when you file an offer and compromise with the IRS, they ask you who's in your family. And if you're unable to count your correct family size, you're going to have a harder time settling any tax debt that you may have. So it just has this ripple effect across a lot of different areas within the tax code and outside the tax code.

And then the very beginning of this, when this first hit, the ITIN unit forgot about head-of-household filing status, so the fact that you can claim a parent who's not living with you. So there was a lot of advocacy that went in to reminding the ITIN unit, "No, no, no, no, no, no, we still get the head-of-household filing status for these families," and so getting that situated and then also other dependent children — so qualifying relatives that lived within the United States, that was also a battle. So there was this other requirement that the ITIN unit set in place, which was proving U.S. residency for many of the dependents that were on the return. So hopefully that explains what a broad impact this had on these families.

Robert Goulder: Well, let's talk about fixing it. Now, let's say that you were in charge of the government, you ran Congress, you were the ultimate decision-maker, and your article is called "Righting a Tax Wrong," do you have a preference in terms of just returning to the pre-TCJA framework?

Sarah Lora: For these families, yes. I think that for these families, returning to pre-TCJA would be the best option because that would most accurately reflect correct family size. And maybe even I've even thought of, "Well, if we wanted to keep the basic structure of the previous of the TCJA, then what we could do is maybe put a minimal dependent exemption amount, $100 per dependent, and that would create the allowable tax benefit for the ITIN unit." And then the one that I suggest, which I think is probably the easiest in the event that Congress wants to keep the whole TCJA structure in place, which seems like — I can't tell what's going to happen, I don't have a crystal ball, but it seems like that probably is the direction that Congress is going to go. In that case, the easiest, simplest fix would be what I propose in the article, which is to eliminate the language that cuts out Canada and Mexico from the other dependent credit.

Now, like I alluded to, so the allowable tax benefit, this assumes that the family has some sort of tax liability, and having the dependent actually helps reduce their tax liability that there is tax due to have a credit to offset that. So it's not perfect, but I think it is the easiest, simplest way to get back to where we were. Without this, I did a simple calculation in the article and found that the tax increase between pre-Tax Cuts [and] Jobs Act and post-Tax Cuts and Jobs Act was about 48 percent tax increase for these families, putting this back in place with the other dependent credit, put it back to just a slight increase in taxes. So I think it would help the bulk of the people that we're talking about here.

And I do think it was a mistake. I believe that if Congress could read my article, they would be horrified to think that, "Oh, we're paying for this on the backs of these families? That's not fair. That doesn't seem just." And so I think that they would say, "Oh yeah, this is a no-brainer. We should just do this."

Robert Goulder: Okay, final question. Now, some lawmakers are always complaining about instances of alleged fraud being associated with these broadly available tax credits. Some of those grievances might be legitimate. Others, I'm thinking not so much. Can you tell us in the context of the ODC, do we really need something as harsh as this section 24(h)(4)(B)? Do we need something like that to address lawmakers' concerns about fraud?

Sarah Lora: So fraud was dealt with in the PATH Act. We said, "We are getting rid of all the ITINs issued prior to 2013, and we are going to require people to send original documents, original passports, original birth certificates to the ITIN unit so that they can review them in front of their faces." And this change in the law, I believe, it hugely confronted the fraud issues that were plaguing the ITINs prior to the PATH Act. So I think the concerns of fraud have been dealt with. There may be a few bad actors here and there.

I've been working with immigrant families for 20 years. I have never once had any family that was even a tax protester. I get that with some of my other clients, but I have never even had a tax protest. There's just this utmost reverence for the tax system and wanting to be compliant and wanting to fulfill their civil obligations to the country in which they live. And I've just never seen that out of the hundreds of clients I've worked with. Obviously, I'm one advocate in one area of the country. I don't see everything, obviously.

But I believe if there is fraud happening, it's one or two bad actors. In fact, the early TIGTA report that I read was talking about a single address where a bunch of ITINs were being mailed and a single address where a bunch of refunds were being mailed. To me, that suggests there's a few bad actors out there, but it's not an overwhelming problem throughout the tax system.

And then the other dependent credit, as I described before, is an itty-bitty nonrefundable credit. It's not one of those credits like the earned income tax credit or the child tax credit, where people are getting refund checks sent to them from these tax returns. It's just a nonrefundable credit that helps offset the reduction of the dependent exemption amount to zero for these families. And we have been with this language of country contiguous since the very beginning of the individual tax code. And I just don't believe that Congress intended to get rid of it. And I do think that the nature of the other dependent credit as being a nonrefundable, itty-bitty credit is another way in which fraud just doesn't come into play as much as some of the other credits.

Robert Goulder: Yeah, I think so too. So that should settle the fraud question. And there you have it. That's all the time we have for today. Again, the author is Sarah Lora. The article is, "Righting Tax Wrongs for Immigrants," and you can find it in the Pittsburgh Tax Review. Sarah, thank you so much for joining us.

Sarah Lora: Thank you so much. Thanks for having me.

David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what do you have for us?

Paige Jones: Thanks, Dave. In Tax Notes Federal, Susan Morse examines the six-year default limitations period for claims against the federal government. Amy Chapman and Timothy Nichols examine the history of payment allocation in the context of distressed debt. In Tax Notes State, Billy Hamilton examines efforts to address housing affordability and homelessness. Craig Griffith examines the debate surrounding West Virginia's taxation of streaming services. In Tax Notes International, six KPMG practitioners summarize how tax authorities around the world are applying the OECD control of risk framework. Reuven Avi-Yonah examines whether the United States should adopt a principal purpose test over the limitation on benefits rule. And finally, in featured analysis, Nana Ama Sarfo examines Kamala Harris's evolution on tax policy legislation.

David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W, and be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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