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Divorce and Taxes: Who Claims the Kids on Your Tax Return?

by
Jorge Gomez
on
11/28/2016
Divorce and Taxes: Who Claims the Kids on Your Tax Return?

Divorce and separation are challenging enough, but when there are children involved the process can become even more difficult. One of the issues that few people anticipate when contemplating a divorce is the management of tax credits and write-offs having to do with dependency and other child-related benefits. These rules surrounding these issues are highly complicated, and making decisions as to what the right way to distribute tax benefits is made all the more stressful if the parents are not able to discuss the subject calmly. The questions involve which parent is entitled to taking the dependency tax exemption, child care credit, child tax credit, and higher-education tuition credit if applicable. Also at issue are filing status and earned income tax credit in some situations.

What is important to remember is that the various benefits and write-offs that are available to parents are among the most challenging to understand under the best of circumstances, in intact families. Taking a situation where one parent may seek a financial advantage over the other – or even to inflict harm – can not only end up causing harm, but may put you in jeopardy of violating the law. The goal in all cases should be to find the answer that is the most advantageous for all involved and to achieve the greater good, and there are a number of good answers for how to negotiate one person taking the credits and providing appropriate compensation to the other.

When a couple has divorced and custody has been determined, that status weighs heavily on the interpretation of the various tax laws. Generally speaking, a parent that has physical custody of a child is considered to be the one who is eligible to claim them as a dependent, even if the other parent is providing the lion’s share of monetary support. That being said, the custodial parent is always able to grant the other parent the right to claim the child as a dependent and take the exemption: all that is needed is a signed copy of the appropriate tax form, which is to be attached to both parents’ tax returns. It is essential, however, that the parent who relinquishes the right to claim the exemption is fully cognizant of the tax ramifications of doing so. Along with the dependency exemption comes other benefits that are given up when you sign the form. Make sure that you talk to your financial advisor before agreeing to shift the dependency exemption.

In situations where two parents who are divorced have agreed to (or been assigned) joint physical custody, the parents must come to some kind of agreement regarding the dependency benefit because only one is permitted to claim the exemption.  Some parents agree to alternate years for the claim, but if no such agreement can be reached then the Internal Revenue Service provides clear tiebreaker rules that state that whichever parent has more nights of physical custody per year will have the dependency exemption. In those cases where both parents have equivalent physical custody, the IRS deems the parent whose adjusted gross income is higher as the one who is entitled to take the tax benefit. 

Child’s Exemption

For tax year 2016, the child tax exemption is a straight deduction of $4,050 off of the parent’s income. There is, however, a threshold for this benefit: for those taxpayers who are single, the phase out begins with an Adjusted Gross Income of $259,400. Those who file using the head of household filing status start phasing out with an adjusted gross income of $285,350, while taxpayers who are married and filing jointly begin phasing out of the child tax exemption benefit with an adjusted gross income of $311,300. If you are entitled to claim the child as a dependent but turning over the deduction to your ex-spouse would result in a greater benefit, it may be worthwhile to discuss providing it to them and having them compensate you for the opportunity to do so.

Head of Household Filing Status

Filing as head of household offers a number of attractive tax benefits and advantages, but it is important to make sure that you qualify for that status before taking it. If you are a parent who is unmarried (which is distinct from being single) and you pay greater than 50% of the costs of a home that is the child’s principal residence for more than half of the year, then you qualify for the filing status, no matter who takes the child tax exemption.

Tuition Credit

Unlike the head of household filing status, the tuition credit is only available to the parent that claims the child’s tax exemption. This credit may be taken as either the Lifetime Learning higher education tax credit or the American Opportunity credit, both of which reduce the amount of tax owed rather than lowering the reported income. The difference is significant, as taking the child deduction has the potential for lowering an income bracket, where the tuition credit actually provides a tax credit, some of which may be refundable. It is important to remember that there are income thresholds for these tax credits. The American Opportunity Tax Credit, which can provide up to a $2,500 credit, phases out between $65,000 and $80,000 for unmarried taxpayers. For married taxpayers the phase-out is between $130,000 and $160,000.

Child Care Credit

Custodial parents are able to take advantage of a nonrefundable tax credit. This credit is designed to provide relief for expenses on child care that enables the parent to work or to look for work. It is only available for children who are younger than 13 and who are written off as dependents, though in cases where parents are either separated or divorced, there is a special rule that allows custodial parents to provide the exemption to the non-custodial parent and still take the credit. When this occurs, the noncustodial parent is not permitted to take the child care credit – only one parent can get this nonrefundable tax credit.

Child Tax Credit

A parent who claims a child under the age of 17 as a dependent is also able to take a tax credit of $1,000 as long as their income falls under the high-income threshold. The threshold for phase-out begins at $110,000 for those who use the married filing jointly status and $75,000 for unmarried parents.

Affordable Care Act

The Affordable Care Act imposes penalties on parents who do not have health insurance coverage, and in cases where parents are divorced, this penalty is imposed on the parent that claims the child as a dependent.

Earned Income Tax Credit (EITC)

Parents who earn either wages or self-employment income may qualify for the Earned Income Tax Credit, which is specifically available for those who earn lower incomes. The calculation for determining eligibility is based upon income and how many children under the age of 19, or if they are full time students and under the age of 24. If you are a custodial parent who releases the dependency exemption to your ex-spouse, you do not lose your ability to get the earned income tax credit. Noncustodial parents who take the tax exemption are still prohibited from using the number of children that they have to qualify for the EITC – only the custodial parent can use the children for this credit. 

There are a lot of tax benefits that come with having children, and understanding which ones you are entitled to is complicate under the best of circumstances. When the issues are complicated by divorce, questions of who is entitled to take what write-off become even more complex. Seek assistance from a qualified tax advisor before relinquishing any of your rights or taking a deduction to which you are not entitled.

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Jorge Gomez

Jorge Gomez

President

As an economist, management accountant, and certified tax planner, I draw on over 20 years of experience supporting small businesses with their tax and accounting needs. I’ve made it my mission to help my clients have access to financial capital while building and maintaining healthy accounting systems to achieve tax compliance and savings. I specialize in working with distribution, wholesale, franchise, and manufacturing businesses while offering a focused approach to saving them money while

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