Tax Snippet #3 – The Exemption for a Dependent – Who Gets to Keep It? The IRS will, in most circumstances, dub the person with whom the child lives the majority of the time as “The Custodial Parent”. This is true unless your settlement agreement and/or divorce decree clearly states otherwise, e.g. one parent is officially named the “primary custodian”.2 Why is it important, for tax purposes, which parent the IRS views as the “custodial parent”? Because, the custodial parent, by default, gets to keep the child exemption for a dependent child – a good savings for most people.
What happens if your settlement agreement/divorce decree states that custody be “shared equally” by the parents? Confusion and trouble, if you don’t make some decisions. To help in these situations, the IRS has implemented default criteria to determine who, in fact, is the “custodial parent”. The IRS looks at whether:
- Your child is under age 19 at the end of the year (or under age 24 at the end of the year if a full-time student);
- Your child has lived with you for more than half the year;
- Your child has provided less than half of his/her support for the year.
The trouble comes when two taxpayers meet all of the criteria above and their settlement agreement/divorce decree is silent as to which parent gets the dependency deduction. What to do? The IRS has made a tiebreaker for these circumstances:
- The custodial parent is the one with whom the child spent the most number of nights in the tax year in question.
But, what if the parents truly shared time with their child (ren) on a 50-50% basis?
- The IRS will grant custodial parent status on the parent who has the highest adjusted gross income.
Is the dependent child deduction “bargainable”? Yes. Some people trade off the exemption (every other year), some split up the children (e.g., dad takes the boy, mom takes the girl), some negotiate the deduction in exchange for something else of value, and some couples (smart ones) go to an accountant to see what the true benefit would be to each of them before making proposals and engaging in negotiations regarding the dependent child exemption.
As of this writing, the IRS requires the custodial parent to complete and sign IRS Form 8332 and have it attached to their and the other parent’s tax return if the primary custodian is giving away her/his right to the deduction. (This has not always been the case and you should check on the rules each and every year that you file your taxes to see what the IRS has cooked up on this one.
2Of course, if your child’s living situation directly contradicts your divorce paperwork, this can create lots of problems and you may want to consider renegotiating your written parenting arrangements sooner rather than later.
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Tax Snippet #4 – Head of Household. Somewhere in between “married”, “married filing separately” and “single” is the divorced taxpayers’ best friend: “head of household” status. What is that? Filing as “head of household” usually nets you:
- A lower tax rate than if you claim a filing status of single or married filing separately;
- Allows more liberal income limits before the IRS puts a damper on your child tax credit (same for retirement account contributions);
- You may be able, if you are still married, to claim certain credits (such as the dependent care credit and the earned income credit) that you cannot claim if your filing status is married filing separately;
- It increases the income limits that reduce your child tax credits.
You must meet the following criteria to be eligible to file as “head of household”:
- You file a separate return (if you are still married);
- Your spouse did not live in your home during the last 6 months of the year (whether or not you are yet divorced);
- You paid over half the cost of keeping up your main residence;
- You qualify to claim your children as dependents (whether or not you have kept or given away the dependency deduction to the other parent); and
- Your home was the main home of your child for more than half the year.
These Tax Snippets are written based on my observations and experience. I am and not a CPA, tax planner or tax attorney. I am a mediator and former family law attorney. These are, however, some of the key issues that I see over and over again with my clients. This series of articles is intended to help you “get your feet wet” in this mucky area of divorce. If you think any of these issues might affect you, see your tax professional for up-to-the-minute and personally-tailored tax advice.