Divorce generally causes tax issues — especially when the couple has children. One common issue that comes up is determining which parent is allowed to claim a child's dependent exemption deduction and other child-related tax breaks. Two U.S. Tax Court decisions provide reminders about when noncustodial parents are allowed to claim the write-offs.
Before we cover the decisions, let's review the rules for the most-common child-related deductions and credits.
After a divorce, a child is generally treated as belonging for most federal income tax purposes to the parent who has custody for the greater part of the year. That parent is called the custodial parent. The other parent is called the noncustodial parent. So under the general rule, for example, only the custodial parent can claim the dependent exemption deduction for a child.
An exception to the preceding general rule allows the custodial parent to release to the noncustodial parent the right to claim the designated child as a dependent. Making this concession doesn't help the custodial parent's tax situation, but may be a necessary part of settling the divorce. Let's call this exception to the general rule the noncustodial parent rule. As you will see, it's an important tax-saving provision for noncustodial parents.
Under the noncustodial parent rule, the designated child is treated as a qualifying child of the noncustodial parent if all the following requirements are met:
Support Requirement. More than half the child's support for the year must be provided by one or both parents.
Divorced or Separated Requirement. The parents must be divorced or separated under a written agreement at the end of the year or have lived apart during the last six months of the year.
Custody Requirement. The child must be in the custody of one or both parents for more than half the year.
Written Declaration Requirement - The custodial parent must sign a written declaration releasing to the noncustodial parent the right to claim the designated child as a dependent for the year. The only sure-fire way to meet this requirement is to have the custodial parent sign IRS Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent. The release can be for one year, for designated years, or for all years.
The noncustodial parent must then attach a copy of the signed Form 8332 to his or her Form 1040. Alternatively, the noncustodial parent can attach to his or her return a statement that "conforms to the substance" of Form 8332. However the conforms-to-the-substance standard is open to interpretation, which is not in the best interest of the noncustodial parent.
Key Point: The noncustodial parent should always, if at all possible, have the custodial parent sign off on a Form 8332 in conjunction with signing off on other divorce documents.
When all the preceding requirements are met, the noncustodial parent is eligible for the valuable tax breaks listed below with respect to the designated child. Correspondingly, the custodial parent is ineligible.
The Dependency Exemption Deduction, which is $4,150 for 2018 (up from $4,050 in 2017).
The Child Tax Credit, which is $1,000 for each eligible child (subject to phase-out for higher-income parents).
There Are Higher Education Tax Credits. The American Opportunity credit can be worth up to $2,500 during the first four years of a child's college education. The Lifetime Learning credit can be worth up to $2,000, and it covers just about any higher education tuition costs. Both credits are phased out as the parent's income goes up, but the Lifetime credit is phased out earlier.
The Higher Education Tuition Deduction can be as much as $4,000 for higher education tuition and mandatory enrollment fees. At higher income levels, the maximum deduction drops to $2,000 before being completely disallowed at still-higher levels.
The Student Loan Interest Deduction can be up to $2,500 for qualified student loan interest expense paid by the parent (subject to phase-out for higher-income parents).
Key Point: When the noncustodial parent rule isn't in effect for the child in question, the tax breaks listed above are completely off limits for the noncustodial parent, but they can usually be claimed by the custodial parent.
As mentioned earlier, one of the requirements for treating a child as the qualifying child of the noncustodial parent is that the custodial parent must sign a written declaration — preferably using IRS Form 8332 — that he or she will not claim that child as a dependent for the tax year in question. Two Tax Court decisions illustrate how important Form 8332 can be for divorced parents.
1. In Armstrong, the noncustodial parent, the father in this case, did not attach Form 8332 to his tax return because his ex-wife failed to sign the document. The Tax Court ruled that the father could not claim a dependent exemption deduction for his son. The father did attach a signed state court order, but the Tax Court said that document did not "conform to the substance" of Form 8332 because it did not contain an unequivocal statement by the ex-wife that she would not claim the child's dependent exemption deduction. In other words, even though the divorce court specified that the father was entitled to claim the son as his dependent, not having a signed Form 8332 (or the equivalent) was a fatal misstep. (Billy Armstrong, 139 TC No. 18)
2. In George, the Tax Court ruled that the mother of the child in question, who was the custodial parent, was not entitled to the child's dependent exemption deduction. The exemption belonged to the noncustodial father, because the mother had signed a Form 8332 releasing the exemption to him, as required by a state court order. However the mother believed the court order was improper. So she claimed the dependent exemption deduction on her return. The Tax Court concluded that the signed Form 8332 locked in the mother's release of her claim to the exemption, which allowed the father to properly claim the exemption and precluded the mother from doing so. (Rachel George, 139 TC No. 19)
If you have questions or want more information about child-related tax breaks in divorce situations, consult with your tax advisor and attorney for details. Child-related tax breaks can be valuable, but parents need to avoid tax-rule pitfalls that are easy to fall into without professional guidance.
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