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CAUTION – The decision to relinquish dependency should not be taken lightly, as it impacts a number of tax benefits.
On the other hand, if a court awards joint physical custody of a child, only one of the parents can claim the child for tax purposes. If the parents cannot agree on who will claim the child and the child, or if both actually claim the child, the IRS tiebreaker rules apply. Per these rules, a child is treated as a dependent of the parent with whom the child resided for the greater number of nights during the tax year; if the child resides with both parents for the same amount of time, the parent with the higher adjusted gross income claims the child as a dependent.
Child Care Credit – A nonrefundable tax credit is available to the custodial parent to offset the cost of child care, provided that the parent is gainfully employed or seeking employment. To qualify for this credit, the child must be under the age of 13 and be a dependent of the parent. However, there is a special rule for divorced or separated parents; when the custodial parent releases the child’s exemption to the noncustodial parent, the custodial parent still qualifies for the child care credit, and the noncustodial parent cannot claim that credit.
Child Tax Credit – A credit of $2,000 is allowed for each child under the age of 17. This credit goes to the parent who claims the child as a dependent. Up to $1,400 of the credit is refundable if the credit exceeds the tax liability. However, this credit phases out for high-income parents, beginning at $200,000 for single parents and at $400,000 for married parents filing jointly.
Medical Insurance – Parents must keep in mind that, under the Affordable Care Act, if a child does not have medical insurance during any part of the year, the parent who claims the child as a dependent is the one who is responsible for any applicable penalties. This is only an issue for the years 2014 through 2018, as the recent tax reform eliminated the penalty for subsequent years.
Earned-Income Tax Credit – Low-income parents with earned income (either wages or self-employment income) may qualify for the EITC, which is based on the number of children (all those under age 19, plus full-time students under age 24), up to a maximum of three children. Releasing dependency to the noncustodial parent does not disqualify the custodial parent from using children to qualify for the EITC. In fact, the noncustodial parent is prohibited from claiming the EITC based on children whose dependency the custodial parent has released.
Alimony – The recent tax reform also impacts the tax treatment of alimony. For divorce agreements that were finalized before the end of 2018, the recipient (payee) of the alimony must include that income for tax purposes. The payer in such cases is allowed to deduct the payments above the line (without itemizing deductions); this is technically referred to as an adjustment to gross income. The recipient who includes this alimony income can treat it as earned income for purposes of qualifying for an IRA contribution, thus allowing the recipient to contribute to an IRA even if he or she has no income from working.
Because some of those who make alimony payments will claim that they paid more than they actually did, and because some recipients will report less alimony income than they actually received, the IRS requires that the paying spouse’s tax return include the recipient spouse’s Social Security number so that the IRS can use a computer to match the amount received to the amount paid.
For divorce agreements that are finalized after 2018, alimony is not deductible by the payer and is not taxable income for the recipient. Because the recipient isn’t reporting alimony income, he or she cannot treat it as earned income for the purposes making an IRA contribution.
This revised treatment of alimony also applies to any divorce or separation instrument that is executed before the end of 2018 but modified after that date – if the modification expressly provides that the tax reform provisions apply.
As you can see, some complex rules apply to divorce situations. Please consult this office if you have any questions related to a pending divorce action. Please note that, if this office has been providing services to both parties in a pending divorce, there are some inherent conflicts of interest in providing advice or preparation services to both parties, so this office may be able to provide services to only one member of the former couple.
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