The divorce rate is at an all time high in our area and we continually run into issues with recently divorced parents trying to claim their children. Below is detailed look at what to do while you are going through the separation process and how easy it is to make a mistake and have a larger tax bill.
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How to Properly Claim your Children after Divorce
IRC Sec. 152 contains a definition of qualifying child that is used to determine eligibility for a number of potentially valuable federal income tax breaks. IRC Sec. 152 also includes rules for determining when a divorced or separated parent can treat a child as that parent’s qualifying child. Usually, a child is the qualifying child of the parent with whom the child resides for the greater number of nights during the year. That parent is termed the custodial parent, and he or she can generally claim the tax breaks associated with the child. The other parent is called the noncustodial parent, and he or she is generally left out in the cold.
However, IRC Sec. 152(e) provides a special rule that allows the custodial parent to release to the noncustodial parent the right to claim the designated child as a dependent. This, in turn, allows the noncustodial parent to claim certain tax breaks associated with the child. Let’s call this special rule the noncustodial parent rule. In the right circumstances, it can be worth significant bucks to a noncustodial parent..
Here are the basics on how the noncustodial parent rule works and why it’s important, along with some recent developments.
How the Noncustodial Parent Rule Works
Under the noncustodial parent rule, a child is the qualifying child of the noncustodial parent if all the following five tests are passed for the calendar year in question.
1. Support Test. The child receives over half of his or her support from the parents.
2. Divorced or Separated Test. The child’s parents are divorced or legally separated under a decree of divorce or separate maintenance, they are separated under a written separation agreement, or they lived apart at all times during the last six months of the year.
3. Custody Test. The child is in the custody of one or both of the parents for over half the year.
Warning: According to Reg. 1.152-4(c), the custody requirement can only be met if applicable state law gives 1 or both parents the right to physical custody of the child. Generally, there is no such parental right after a child reaches the legal age of majority (age 18 or 21 in most states). Therefore, it may be impossible to meet the custody requirement for an older child. If the custody requirement is not met, the noncustodial parent rule cannot possibly apply, and the question of who can claim the child as a dependent must be decided using the “regular” rules under IRC Sec. 152. That determination will also affect who can claim the various other child-related tax benefits discussed in this article.
4. Written Declaration Test. The custodial parent signs a written declaration releasing to the noncustodial parent the right to claim the child as a dependent for the year. According to Reg. 1.152-4(e), the declaration must (1) be an unconditional release of the custodial parent’s claim to the child as a dependent for the years the declaration is effective, (2) name the noncustodial parent to whom the exemption is released, and (3) specify the years it is effective. A declaration is not unconditional if it requires the noncustodial parent to satisfy any condition, including being current on child support payments. The declaration is generally made by having the custodial parent sign IRS Form 8332
(Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent). Alternatively, the required written declaration can be made on another document that conforms to the substance of Form 8332.
Warning: When Form 8332 is not used, the required written declaration must be made on a separate document that is executed for the sole purpose of releasing to the noncustodial parent the right to claim the child as a dependent for one or more years. This rule means that a written declaration cannot simply be included within the text a court order, decree, or separation agreement. [See Reg. 1.152-4(g), Example 18.] However, written declarations that were executed on or before 7/2/08 are still okay, as long as they complied with the rules in effect at the time they were executed.
5. Return Attachment Test. The noncustodial parent attaches to his or her Form 1040 for the applicable year a copy of the signed written declaration (Form 8332 or the equivalent).
Why the Noncustodial Parent Rule Is Important
When all of the preceding five tests are passed, the noncustodial parent is eligible for the following tax breaks with respect to the child to whom the noncustodial parent rule applies (assuming all the other qualification rules for these breaks are also met).
1. Section 152 Dependency Exemption Deduction. For 2015, this deduction is $4,000 (subject to phaseout for higher-income parents). IRS Notice 2006-86 says the deduction for a child to whom the noncustodial parent rule applies always belongs to the noncustodial parent.
2. Section 24 Child Tax Credit. This credit is $1,000 per eligible child (subject to AGI-based phaseout).
This outcome is explicitly provided for by statute because the child tax credit can only be claimed for a child who is the taxpayer’s qualifying child and for whom the taxpayer can claim a dependency exemption deduction.
3. Section 25A Education Tax Credits. A parent can claim the American Opportunity or Lifetime Learning Credit for qualified tuition and related expenses incurred for a child for whom that parent can claim a dependency exemption deduction. Therefore, when the noncustodial parent rule applies to a child, the noncustodial parent can claim a Section 25A credit for that child’s education expenses, and the custodial parent cannot.
4. Section 221 Student Loan Interest Deduction. A parent can claim a deduction for up to $2,500 of qualified education loan interest expense incurred for a child who is that parent’s qualifying child under the Section 152 rules. Therefore, when the noncustodial parent rule applies to a child, the noncustodial parent can claim the Section 221 deduction for interest paid on education loans taken out for that child, and the custodial parent cannot.
5. Section 222 Tuition Deduction. Assuming this break is extended (it expired at the end of 2014), a parent can claim a deduction for up to $2,000 or $4,000 of qualified tuition and related fees for a child for whom that parent can claim a dependency exemption deduction. Therefore, when the noncustodial parent rule applies to a child, the noncustodial parent can claim the Section 222 deduction for qualified tuition and fees paid for that child, and the custodial parent cannot.
6. Other Tax Breaks. Whether or not the noncustodial parent rule applies to a child, both parents can generally take advantage of the following tax breaks: (1) itemized deductions for that child’s medical expenses, (2) HSA contributions based on that child’s status as a dependent, (3) tax-free reimbursements for that child’s medical expenses under IRC Secs. 105(b) and 106(a), and (4) tax-free treatment for employee discounts and no-additional-cost services provided to that child].
This rule applies as long as: (1) the parents together provide over half of the child’s support for the year, (2) the child is in the custody of one or both parents for over half the year, and (3) the child meets the definition of a qualifying child of one of the parents under IRC Sec. 152(4). However, if these conditions are not satisfied, and the noncustodial parent rule doesn’t apply to the child, the aforementioned tax breaks are off limits to the noncustodial parent.
Some Tax Breaks Are Strictly Off-limits for Noncustodial Parents
Even when the noncustodial parent rule applies, the noncustodial parent cannot claim head of household status based on a child to whom the noncustodial parent rule applies. Also, a noncustodial parent is not entitled to the child and dependent care credit under IRC Sec. 21, earned income credit under IRC Sec. 32, or income exclusion for dependent care assistance benefits under IRC Sec. 129 for a child to whom the noncustodial parent rule applies. (See Notice 2006-86.) These breaks generally belong to the custodial parent. In any case, the noncustodial parent cannot claim them based on a child to whom the noncustodial parent rule applies.
Importance of Obtaining Signed Form 8332 to Activate Noncustodial Parent Rule
In the facts underlying the Tax Court’s 2014 Swint decision, Lisa Swint had filed a joint 2009 federal income tax return with her husband, Tommy Swint, who had fathered a child in a previous relationship. In
1998, an agreed entry between Tommy (the noncustodial parent) and the child’s mother (the custodial parent) was filed with the Common Pleas Court of Montgomery County, Ohio, Juvenile Division. The agreed entry allowed Tommy to claim the child as his dependent and claim the related child tax credit—as long as he remained current on his child support obligations. Neither party signed the agreement.
After an audit of the now-deceased Tommy’s joint 2009 federal income tax return with Lisa, the IRS disallowed the dependency exemption and child tax credit claimed on the return. The now-widowed Lisa took her case to the Tax Court where she argued that the agreed entry filed with the Common Pleas Court was sufficient to meet the written declaration requirement rules that were in effect at that time and that
Tommy’s child could therefore be claimed as a dependent on the joint 2009 return.
The Tax Court sided with the IRS by concluding that the agreed entry was insufficient for two reasons.
First, it was not signed by the custodial parent (the child’s mother). Second, the agreed entry did not unconditionally release the custodial parent’s (mother’s) right to claim the child as a dependent. Instead, the release was conditioned on Tommy staying current on his child support obligations. The fact that Tommy did stay current did not help his cause because the issue was whether the custodial parent’s release was unconditional. Since it was not, the case was closed in favor of the IRS.
Note: The pre-7/3/08 written declaration rules that were applicable to the Swint case were not exactly the same as the current written declaration rules. The important thing to understand is that the very-similar current rules must be met for a noncustodial parent to claim the child-related tax breaks.
In the facts underlying the Eighth Circuit’s 2014 Armstrong decision, the taxpayer’s court-ordered divorce decree awarded him the dependency exemptions for his two children, who lived with his ex-wife, as long as he stayed current on his child support obligations. However, the court order did not require the ex-wife to provide the taxpayer with a signed Form 8332. Although the taxpayer made his child support payments as required, the ex-wife never provided him with a signed Form 8332. The Eighth Circuit concluded that the court order did not unconditionally establish that the ex-wife would not claim dependency exemptions for the children or that she would provide a signed Form 8332. Therefore, the taxpayer was not entitled to claim the exemptions for the two children.
Custodial Parent Can Unilaterally Negate Noncustodial Parent Rule
According to Reg. 1.152-4(e)(3), the custodial parent can unilaterally revoke an earlier release to the noncustodial parent of the right to claim a designated child as a dependent. In other words, a signed Form
8332 previously provided to the noncustodial parent can be nullified later on by the custodial parent. This unilateral revocation rule effectively allows the custodial parent to yank from the noncustodial parent the federal income tax benefits associated with the noncustodial parent rule, with or without cause. The regulation says a revocation is allowed even when the divorce papers clearly stipulate that the custodial parent must release to the noncustodial parent the right to claim the designated child as a dependent. [See
Reg. 1.152-4(e)(3) and 1.152-4(g), Example 20.]
How to Make Revocation. A revocation is accomplished by attaching to the custodial parent’s Form 1040 a copy of Form 8332 (or a successor form issued by the IRS). Alternatively, a revocation can be made with a separate document that conforms to the substance of Form 8332 (or a successor form) and that is executed for the sole purpose of revoking an earlier release to the noncustodial parent of the right to claim the designated child as a dependent.
Tax Years Affected by Revocation. A revocation must specify the year or years for which the revocation applies, and a copy must be attached to the custodial parent’s Form 1040 for each year that the revocation applies. A revocation for all future years is treated as taking effect starting with the first year after the year during which the revocation is executed.
Noncustodial Parent Must Be Notified. The custodial parent must provide the noncustodial parent with written notice of the revocation or make reasonable efforts to provide such notice. The revocation cannot take effect any earlier than the year after the year in which the custodial parent provides notice to the noncustodial parent (or makes reasonable efforts to provide such notice). The custodial parent must keep a copy of the revocation and evidence of delivery of the required notice to the noncustodial parent (or attempts to deliver such notice).
Conclusion
In divorce situations, potentially valuable child-related tax breaks can be up for grabs between the two parents. The noncustodial parent rules can be very beneficial for the noncustodial parents of the world. That said, it is critical for the noncustodial parent to obtain a signed Form 8332 from the custodial parent.
Experience shows that it is best to obtain the signed Form 8332 while all the other divorce-related papers are being signed and exchanged because cooperation later on