Just Divorced? How being the custodial parent may impact your taxes in 2014

Taxes
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By Kent Bone, EA

Learn more about Kent on NerdWallet’s Ask an Advisor 

Legally, a divorce decree may give physical custody to one parent or the other, but to the IRS, “custodial parent” follows federal tax law which may not be in accordance with the divorce agreement.  The determination of custodial parent is critical for the child related tax benefits associated with the tax returns of both parents.  Those benefits are:

  1. Head of household filing status;
  2. Earned income tax credit;
  3. Dependent exemption;
  4. Child tax credit;
  5. Education deduction or credits;
  6. Student loan deduction;
  7. Non-taxable income for dependent care assistance benefits; and the
  8. Dependent care expense deduction.

Federal tax law governing the determination of custodial parent is found in Reg. §1.152-4(e)(1).  Basically, this section gives the custodial parent, and only the custodial parent, the following benefits:

  1. Head of household filing status;
  2. Earned Income Credit;
  3. Tax-free dependent care benefits; and the
  4. Dependent care expense deduction.

The custodial parent can waive the right to claim a child as a dependent and give those associated benefits to the non-custodial parent only by completing Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent.  An agreement between parents (divorce decree or verbally) does not alter Reg. §1.152-4(e)(1) as to the determination of the custodial parent; so, only when this wavier is completed, does the non-custodial parent receive the following benefits as given in Reg. §1.152-4(e)(2):

  1. The dependency exemption;
  2. Child tax credit;
  3. Education tax deductions or credits;
  4. Student loan interest; and the
  5. Tuition deduction.

So, in case of a dispute, who meets the federal tax law definition of custodial parent?  Think of the non-custodial parent who pays child support, then files a tax return claiming the child as a dependent and uses some of the deductions and credits intended for the custodial parent.  The IRS generally matches social security numbers of the dependents to find duplicated dependents; an audit of both returns follow.  The IRS resolves this tax custody dispute by examining the facts and circumstance surrounding the following:

  1.  The parents are divorced or legally separated under a divorce decree or separate maintenance agreement, or lived apart at all times during the last six months of the year, married or not;
  2. Over half of the support must be from the parents and;
  3. The child is in custody of one or both the parents for more than half of the year;
  4. Then the child shall be treated, for custody purposes, as receiving over half of their support during the calendar year from the parent having custody for a greater portion of the calendar year (“custodial parent”).  Generally, the determination is made on the greater number of nights, not days. If an equal number of nights are spent with each parent, then the parent with the higher Adjusted Gross Income (AGI) is awarded the custodial parent status.  There are special rules for parents who work nights (see Pub 501). So, forget child support, nighttime custody is the governing set of facts and circumstances.
  5. In addition, one of the following may apply:
    1. The custodial parent signs the written declaration Form 8332, indicating that they agree not to claim the child as a dependent for the current year and this declaration is attached to the non-custodial parent’s return; or
    2. A pre-1985 decree of divorce or separate maintenance agreement states that the agreement applies to the current year and giving the non-custodial parent dependency rights.  In addition, attach a statement that this agreement was not amended after 1984 and that the non-custodial parent has contributed at least $600 toward child support during the current year.

You can see at this point that when the facts and circumstances favor you as the custodial parent, then the IRS will allow you the benefits of:

  1. Head of household filing status;
  2. Earned Income Credit;
  3. Tax-free dependent care benefits; and the
  4. Dependent care expense deduction.

And if you do not complete Form 8332, these benefits will belong to you as well:

  1.  The dependency exemption;
  2. Child tax credit;
  3. Education tax deductions or credits;
  4. Student loan interest; and the Tuition deduction.

Hopefully, given your particular set of facts and circumstances, you and your divorced or separated spouse will have discussed these issues in advance and are following the advice of an experienced tax counselor.  But, if not, you now have a set of rules and guidelines as to who is the custodial parent… and you better understand your rights and benefits according to Federal Tax Law.