Child-related tax exemptions and credits: the basics

Tax exemptions should be considered when making child custody and support arrangements.

When a couple divorces, they have many decisions to make and much information to consider. They need to decide, among other things, who will get custody of the children, who will stay in the marital home, how assets and debts will be divided, and whether any spousal support/alimony is appropriate. With all these issues to consider, one important issue - that could have significant financial ramifications for years to come - could be forgotten: what to do about child-related federal tax exemptions and credits. These exemptions decrease the amount of your income that is subject to tax, which reduces the taxes you owe.

Dependency tax exemption

One of the most important tax exemptions is known as the "dependency tax exemption," and is available to parents who provide support for their children. The dependency tax exemption for 2016 allows parents to exempt up to $3,950 from their overall taxable income for each qualifying child. The amount of the exemption can be reduced or eliminated depending on the parent's income, however.

In situations where parents are divorced or separated for at least six months out of a calendar year, only one parent can seek the exemption for a qualifying child. Dependency tax exemptions are not explicitly custody-specific, meaning that the parent doesn't need to prove that he or she is the parent designated as sole managing conservator or that he or she is the parent who designates the primary residence of the child. In fact, the United States Code says:

If the parents claiming any qualifying child do not file a joint return together, such child shall be treated as the qualifying child of -

(i) the parent with whom the child resided for the longest period of time during the taxable year,

or

(ii) if the child resides with both parents for the same amount of time during such taxable year, the parent with the highest adjusted gross income. (26 U.S. Code § 152(B))

The Code also makes it possible for parents to mutually decide, as part of their divorce decree, that the exemptions alternate from year-to-year or on a set schedule. If a non-custodial parent is claiming the exemption, however, the Internal Revenue Service does require that written documentation, preferably Form 8332, be submitted.

Form 8832 allows the custodial parent to assign the exemption to a non-custodial parent for the current tax year, all future years, a certain number of years or to revoke assignation of the exemption. Though it does represent an additional step in the tax filing process for the non-custodial parent, this could help the parents avoid an audit down the road and prevent accidentally double-claiming the child on two different tax returns.

Earned income tax credit (EITC) and other credits

The EITC is both a residency-specific and income-specific tax credit that allows parents who have primary physical custody of their children to get a variable credit depending on the number of children they support. Only the parent with primary physical custody can claim the EITC. There are also income limits applicable to the EITC, so not all parents are eligible. Unlike the dependency tax exemption, the EITC is not transferable from the custodial parent to the non-custodial parent; the only way to shift who gets to appropriately claim the EITC is to shift primary custody from one parent to the other.

There could also be, depending on the situation, other tax credits or exemptions available for divorced parents, including the dependent care credit (which allows parents to deduct up to $3,000 per child in qualified child care expenses incurred while the parent was working or looking for work).

Tax exemptions, credits and deductions can have a huge financial impact for you following a divorce, both immediately and for years into the future. Whether you are getting divorced or you are interested in modifying an existing divorce decree, you should carefully consider the tax implications of your decisions. For more information about the interplay of divorce and taxes, speak with experienced family law attorney Mysti Murphy. Call her San Antonio law office locally at 210-807-8227 or toll free at 866-986-7807, or send an email today.