When parents separate or divorce, in most cases the parent who will be entitled to claim dependent exemption for their children will be the parent with primary custody. Claiming the exemption for a dependent child can significantly reduce a parent's tax burden.
Parents often want to assign tax deductions for their dependent children in a way that differs from the standard IRS rules for claiming that deduction. Parents with shared physical custody might want certainty as to who can claim an exemption, or to ensure that exemptions are shared in a fair manner. Parents might want to consider their relative earnings, and the relative benefits to each of them from claiming the exemption.
Some parents might want to take turns claiming the deduction. Parents with more than one child might want to allocate a certain number of deductions to each parent. The exemption for an individual child cannot be divided.
Under the IRS rules, in order to be a qualifying child for purposes of the dependent exemption:
The child must be your son, daughter, stepchild, foster child, brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them.
The child must be (a) under age 19 at the end of the year and younger than you (or your spouse if filing jointly), (b) under age 24 at the end of the year, a student, and younger than you (or your spouse if filing jointly), or (c) any age if permanently and totally disabled.
The child must have lived with you for more than half of the year.
The child must not have provided more than half of his or her own support for the year.
The child is not filing a joint return for the year (unless that joint return is filed only to claim a refund of withheld income tax or estimated tax paid).
If the child meets the rules to be a qualifying child of more than one person, only one person can actually treat the child as a qualifying child. The IRS also has a set of rules for parents who are divorced or separated, and living apart, for custody orders that went into effect before 2009. When both parents are equal under the general rule, the IRS applies tiebreaker rules:
If only one of the persons is the child's parent, the child is treated as the qualifying child of the parent.
If the parents file a joint return together and can claim the child as a qualifying child, the child is treated as the qualifying child of the parents.
If the parents do not file a joint return together but both parents claim the child as a qualifying child, the IRS will treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher adjusted gross income (AGI) for the year.
If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.
If a parent can claim the child as a qualifying child but no parent does so claim the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child. If the child's parents file a joint return with each other, this rule can be applied by dividing the parents' total AGI evenly between them; see Pub. 501 for details.
Depending on the outcome of the tiebreaker analysis, parents may be able to choose which parent claims the qualifying child. However, it's generally best to have worked out that issue in advance.
When a divorce judgment awards an exemption to one parent, but it is claimed by the other parent at tax time, the IRS will apply its own rules to determine which parent is entitled to receive the exemption. If the IRS determination differs from the terms of the divorce or custody order, a parent who is unable to claim an exemption awarded by the court that issued the order may return to that court to seek compensation for the amount of money they would have saved or received as a tax refund had they been able to claim the deduction.
The better approach is to include within the court's order a requirement that the parent who is entitled to the deduction under IRS rules complete IRS Form 8332 (Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent), which upon filing with the IRS will entitle the other parent to claim the exemption for the relevant tax year. Form 8832 is filed along with the non-custodial parent's tax return. If a parent refuses to sign Form 8332, it is possible for the other parent to take action with the court before filing a tax return, and thus avoid complications with the IRS.
It is important to fully consider the tax consequences of dividing dependent exemptions before stipulating to their division in a divorce or custody order. For example, if a custodial parent releases the dependency exemption for a child, the custodial parent may not claim the child tax credit for that child in that tax year. It is important to discuss these issues with your custody lawyer or financial planner before making your decision about whether to overrule the default IRS rules in the divorce or custody order.
Starting in 2018, the tax code has been modified such that individuals and married couples can claim a larger standard deduction, but the dependent tax exemption has been eliminated and is not scheduled to be restored until 2025. Parents should consider both how tax law changes may affect their existing child support agreements. When entering into a divorce settlement, parents should also consider the possibility that the exemption will be restored before 2025, and whether their settlement should consider the possibility of an earlier or later restoration of the exemption.