The IRS has issued Notice 2018-70 to clarify the definition of a qualifying relative and exemption amount following changes made in the Tax Cuts and Jobs Act.

Under the Tax Cuts and Jobs Act, exemptions for dependents are set to zero beginning in 2018 by IRC §151(d)(5). However, in IRC §151(d)(5)(B) provides that:

For purposes of any other provision of this title, the reduction of the exemption amount to zero under subparagraph (A) shall not be taken into account in determining whether a deduction is allowed or allowable, or whether a taxpayer is entitled to a deduction, under this section.

The Notice provides guidance on how to apply this provision to a number of provisions tied to the definition of a qualifying relative. The Notice provides:

Construing § 152 in light of the structure of the statute, the Treasury Department and the IRS believe that the exemption amount referenced in that section must be $4,150 (adjusted for inflation), rather than zero, for purposes of determining who is a qualifying relative. This interpretation accords with § 151(d)(5), which aims to suspend the deduction for personal exemptions without substantively changing other Code provisions that directly or indirectly reference the § 151(d) exemption amount.

The IRS notes that a contrary reading of the statute leads to results that are absurd:

For example, to be a qualifying relative under § 152(d)(1)(B), an individual must have gross income that is “less than the exemption amount.” But if the exemption amount were zero, an individual's gross income would have to be less than zero — a near impossibility. And because it would be highly unusual for an individual to have gross income less than zero,1 virtually no individuals would be eligible as qualifying relatives. A zero exemption amount would thus effectively render § 152(d)(1)(B) inoperable and eliminate an entire category of dependents. The Treasury Department and IRS do not believe Congress intended to make such a significant change in such an indirect manner.

In addition, the new $500 credit that Congress enacted at the same time, and in the same Act, as it reduced the § 151(d) exemption amount likewise depends on a non-zero exemption amount in § 152(d)(1)(B). Section 24(h)(4)(A), as amended, creates a $500 credit available for each dependent of the taxpayer other than a qualifying child for whom the child tax credit is allowed. This provision references the definition of dependent in section 152, which includes both qualifying relatives and qualifying children, and it was understood at the time of enactment that this provision “generally retain[ed] the present-law definition of dependent.” H.R. Rep. No. 115-466 at 227. But if the exemption amount referenced in § 152(d)(1)(B) were zero, the entire category of qualifying relatives would be effectively excised from the definition of dependent. As a consequence, the $500 credit generally would not be available for qualifying relatives, and the availability of this credit would shrink to only a limited category of qualifying children for whom the child tax credit is not allowed. This does not appear to be what Congress intended when it enacted the new $500 credit.

Further, head of household filing status also depends on a non-zero exemption amount in § 152(d)(1)(B). Under § 2(b)(1)(A), an individual is considered a head of household if, inter alia, he or she maintains as his or her home a household for either (i) a qualifying child or (ii) “any other person who is a dependent of the taxpayer.” Because the only dependents other than qualifying children are qualifying relatives, a zero exemption amount in § 152(d)(1)(B), and the resulting near elimination of qualifying relatives, would render the express provision for other dependents in § 2(b)(1)(A)(ii) superfluous. It also would deny head of household filing status to many individuals who previously qualified for that filing status and otherwise would continue to qualify. There is no reason to believe that Congress intended its alteration of the § 151(d) exemption amount to have this effect.

Under the terms of this Notice, the reduction of the exemption amount to zero will not apply for purposes of determining if an individual is a qualifying relative under IRC §152(d)(1)(B). Rather, the exemption amount will be deemed to be $4,150 (adjusted for inflation) for years when the exemption amount is set to zero.[1]

[1] Notice 2018-70, Section 3