Divorce causes tax issues. For example, which parent is allowed to claim a host of valuable child-related tax breaks? Sometimes, but not always, it depends on which parent is allowed to claim the child as a dependent. This article explains what you need to know.
Are You the Custodial Parent?
For tax purposes, a child is usually treated as a "belonging" to the parent who has custody for the greater part of the year. That parent is called the custodial parent. The other parent is called the non-custodial parent.
The general rule says that only the custodial parent can claim the dependent exemption deduction for the child. However, an exception to the general rule allows the custodial parent to release to the non-custodial parent the right to claim the designated child as a dependent. Making this concession doesn't help the custodial parent's tax situation, but it is often a necessary part of settling the divorce. We will call this exception to the general rule the non-custodial parent rule. As you will see, it is an important tax-saving provision for all you non-custodial parents out there.
The Non-Custodial Parent Rule Can Mean Big Tax Savings
Under the non-custodial parent rule, the designated child is treated as a qualifying child of the non-custodial parent if all the following requirements are met.
Support Requirement: Over half the child's support for the year must be provided by one or both parents.
Divorced or Separated Requirement: The parents must be divorced or separated under a written agreement at the end of the year or have lived apart during the last six months of the year.
Custody Requirement: The child must be in the custody of one or both parents for over half the year.
Written Declaration Requirement: The custodial parent must sign a written declaration releasing to the non-custodial parent the right to claim the designated child as a dependent for the year. The easiest way to meet this requirement is to have the custodial parent sign IRS Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent. The non-custodial parent must attach a copy of Form 8332 to his or her Form 1040.
When these requirements are met, the non-custodial parent is eligible for the tax breaks listed below with respect to the designated child. (Correspondingly, the custodial parent is ineligible.)
Dependency Exemption Deduction: This deduction is $4,050 for 2017 (unchanged from 2016).
Child Tax Credit: This credit is $1,000 for each eligible child (subject to phase-out for higher-income parents).
Higher Education Tax Credits: The American Opportunity credit can be worth up to $2,500 during the first four years of a child's college education. The Lifetime Learning credit can be worth up to $2,000, and it covers just about any higher education tuition costs. (Both credits are phased out as the parent's income goes up, but the Lifetime credit is phased out earlier.)
Student Loan Interest Deduction: This deduction can be for up to $2,500 of qualified student loan interest expense paid by the parent (subject to phase-out for higher-income parents).
Tuition Deduction: This deduction can be as much as $4,000 for higher education tuition and mandatory enrollment fees. (At higher income levels, the maximum deduction drops to $2,000 before being completely disallowed at still-higher levels.)
Important Point: When the non-custodial parent rule isn't in effect for a child, the breaks listed above are completely off limits for the non-custodial parent, but they can usually be claimed by the custodial parent.
Some Breaks Are Available to Both Parents
Whether the non-custodial parent rule applies or not, the non-custodial parent can usually claim the tax breaks listed below as long as the first three noncustodial parent rule requirements are met (the support requirement, the divorced or separated requirement and the custody requirement). The custodial parent can also usually claim these breaks:
- Itemized deductions for the child's medical expenses paid by the parent.
- Tax-free employer-provided health care benefits for the child.
- Tax-free health savings account (HSA) distributions to cover the child's medical expenses.
Some Breaks Are Only Allowed to the Custodial Parent
The non-custodial parent cannot claim the following breaks based on a child to whom the non-custodial parent rule applies. The custodial parent can if he or she meets the applicable tax-law requirements.
Head of Household Filing Status: Filing as a head of household is better than filing as a single taxpayer, because the standard deduction is bigger and the tax brackets are looser. A non-custodial parent cannot claim head of household filing status based on a child who falls under the non-custodial parent rule.
Earned Income Tax Credit: In 2017 this credit can be worth up to $3,400 for one qualifying child and up to $6,318 for three or more qualifying children (up from $3,373 and $6,269 respectively in 2016). It is phased out as the parent's income goes up. A non-custodial parent cannot claim the credit for a child who falls under the non-custodial parent rule.
Child Care Tax Credit: This credit can range from $600 to $1,050 for one qualifying child ($1,200 to $2,100 for two or more), based on the parent's income. A non-custodial parent cannot claim the credit for a child who falls under the non-custodial parent rule.
Tax-Free Childcare Assistance: This break allows up to $5,000 in federal-income-tax-free reimbursements for qualified childcare expenses under an employer plan. A non-custodial parent cannot receive tax-free reimbursements for a child who falls under the non-custodial parent rule.
