The legal right to claim a child as a dependent for income tax purposes is a significant issue which can easily be overlooked in dealing with all the other issues involved in custody, visitation, and support cases. The non-custodial parent may assume that the custodial parent gets to claim the child and that the issue is not worth the time or cost to pursue.
While in some cases the allocation of the tax dependent status of a child may not be a significant monetary issue at the time the case is pending, the non-custodial parent needs to review all of the aspects of the tax dependent status before deciding whether to pursue the issue.
The need for a tax advisor’s input may be necessary, given some of the issues involved. The issue of tax dependent status is significant to the non-custodial parent due to the presumption under federal income tax laws and rules that the parent with whom the child resides more than 50% of the time is the parent entitled to claim the child for tax purposes. There are special federal tax rules when the parents have exactly equal custody of the child and such situations should be reviewed carefully. However, the right to claim a child as a tax dependent is a property right which the IRS laws and rules allow a court to allocate between the parties.
A state court order or judgment which allocates the right to claim a child as a tax dependent can allow the non-custodial parent to claim the child on his or her taxes for certain purposes. The considerations for granting the non-custodial parent the tax dependent status of one or more of the children generally first turns on the amount of support each party will be providing the child alimony or children. If the non-custodial parent is paying significant support to the custodial parent and/or exercising more than usual visitation (but not more than the 50% of the time which would trigger the IRS rules to allow claiming the child as a dependent), the non-custodial parent has a valid claim to the tax benefit of claiming the child or children.
A secondary consideration may be the relative taxable incomes of the parties and who will benefit more from claiming a child as a dependent. If there are multiple children, the court may split the children for tax purposes. The determination of the relative amounts of support provided by the parents may be determined from financial statements that may be required in a given jurisdiction. The amount of support may be actual expenses for the child or children, or a set percentage of certain household expenses. If such statements are not required by the court, requests for information to the opposing party, called discovery requests, or even the deposition of the other parent, may be necessary to ascertain the expenses the other parent may claim in support of being awarded the right to claim the child as a tax dependent. The parent seeking the dependency exemption should carefully review the other parent’s figures for inflated or extravagant expenses, expenses which are offset by reimbursements or tax savings, or other inaccurate portrayals of the support being provided. An experienced family law attorney can spot the “usual suspects” in a financial statement and challenge the basis for such figures.
In determining which parent benefits more from the ability to claim a child as a dependent, the taxable incomes, or more precisely the applicable tax brackets, of the parties may also play into the decision to award the tax dependent status. For example, for income earned in 2007, the base individual exemption amount is $3,400. However, the base federal exemption is subject to a phased-in reduction to a minimum exemption amount $1,133.
The phased-in reduction is calculate at 2% for each $2,500 or part of $2,500 ($1,250 if you are married filing separately) that the Adjusted Gross Incomes exceeds the amount show for each filing status:
Married filing separately - $117,300
Single - $156,400
Head of household - $195,500
Married filing jointly - $234,600
Qualifying widow(er) - $234,600
For the 28% and higher tax brackets, the reduction in the allowed amount of the exemption will, of course, reduce the value of the exemption correspondingly. A qualified tax advisor should be consulted to determine that value of the exemption for persons subject to the phased-in reduction. As an example of valuing the exemption, claiming one child in 2007 will generate the following tax savings in the applicable tax brackets on the full $3,400 exemption value: Value of Dependent Exemption for 2007 Annual Taxable Income
||Head of Household
||Tax Bracket and Base Value of Exemption
||10% bracket = $340
||15% bracket = $510
||25% bracket = $850
||28% bracket = $952
||33% bracket = $1,122
As many state or local income taxes are based upon the federal numbers, the additional tax savings on these taxes should also be considered. Beyond the individual exemption tax savings, the right to claim a child as a tax dependent also affects the ability to claim the child for other federal tax purposes. The non-custodial parent who can claim the child as an exemption may also claim the child tax credit for the child and claim college or educational expense deductions under the several tax breaks for education costs, regardless of the percentage of time the child lives with the non-custodial parent.
However, the non-custodial parenting divorce cannot claim the child as a qualifying child for head of household filing status, for the credit for child and dependent care expenses, or the earned income credit, even though he claims the child for the individual exemption. Head of household filing status, the credit for child and dependent care expenses, or the earned income credit are still determined by the percentage of time the child lives with a parent and are not altered by a state court order allocating the tax dependent status. As the custodial parent who can not claim the child as a dependent for the individual exemption may still claim the household filing status, the credit for child and dependent care expenses, or the earned income credit, both parents may receive part of the tax benefits.
The custodial parent’s other tax savings should be considered in allocating the dependent status for the individual exemption. Such considerations should include whether the non-custodial parent is paying any daycare costs as additional child support or if the custodial parent is tax sheltering daycare expenses through a flex spending account. Many agreements on the tax dependent status provide for alternating exemptions or splitting children. As noted above, the custodial parent may still obtain tax benefits without the individual exemption dependent status and the college expense deduction requires the individual exemption dependent status to deduct those expenses. Before agreeing to alternate the award of exemptions, or in splitting children for exemptions, consider carefully the impact on the tax benefits involved and who will be paying the college expenses.
It is also usual for agreements on the tax dependent status to require the non-custodial parent be current on support. Since most states have aggressive child custody forums support collection systems and the support obligation remains an outstanding judgment against the parent owing the support, the need to add the possible loss of the tax exemption to the list of punishments for non-payment (such as imprisonment, loss of driver’s license, and tax refund intercepts) seems a minor incentive to stay current on support. Since under such agreements the custodial parent can claim an arrearage and take the exemption without any court ruling or other review, the mistaken claim or malicious abuse of such a provision can trigger an IRS audit, penalties, and fines when both parents claim the exemption. Avoidance of such a “self-help” provision is strongly advised.
The foregoing is an overview of the tax issues with the dependent exemption and, as stated at the outset, review with a tax professional of the current and future tax implications of being able to claim your child as a dependent under any court order or settlement agreement is advised.
Richard Coffee is a Senior Attorney in the Fairview Heights office of Cordell & Cordell.