Most divorcing couples feel financially strained. The good news is that parents may receive significant tax benefits for children; the bad news is that even though more and more parents are choosing joint parenting the IRS still hangs on to the somewhat outdated sole custody approach. The challenge is that you and your spouse cannot simply allocate the benefits any way that you choose, there is another party at the table and that is the IRS.
In today’s world the parents frequently choose joint parenting in which the child resides approximately ½ of the time with each parent. However, the IRS does not have a straightforward solution to allocate benefits in “joint parenting” arrangements. In fact the IRS relies on their own version of who has “custody” to determine how the benefits are allocated. The IRS defines the “custodial” parent as the “one with whom the child lived for a longer period of time” and there is no such things a joint custody as far as the IRS is concerned. According to the IRS the “custodial” designation will be determined by which parent has the child more overnights during the year and if the parents have equal nights then the right to take the benefits will go to the parent who has the higher adjusted gross income.
A couple of the benefits can be transferred to the “non-custodial” parent by the “custodial“ parent giving the “non-custodial” parent a proper release, (Form 8332). In a nutshell the tax benefits that can be easily transferred to the “non-custodial” parent from the “custodial” parent by using this form are:
Dependency Exemption: Each qualifying child can be taken as a dependency exemption by one of the divorce parents; this reduces taxable income by the amount of the exemption currently $4,050 for 2017, reduced by phase out rules for higher income taxpayers. The parent who claims the dependency exemption will also be eligible for a Child Tax Credit.
Child Tax Credit: If the “non-custodial” parent has been given the right to claim the dependency exemption, then that parent is also eligible for Child Tax Credit. This is currently $1,000 for children who are 16 or younger on December 31 of the tax year, reduced by phase out rules for higher income taxpayers.
Tax benefits that the “custodial” parent cannot transfer to the “non-custodial” parent and may be used only if the parent’s status is “custodial” as defined by the IRS are:
Head of Household: The filing status provides a higher standard deduction and a lower overall tax rate than the single filing status.
Child and Dependent Care Credit: Childcare costs are often shared by the parents, but only the parent that is designated the “custodial” parent can take the Dependent Care Credit for children. This benefit can be substantial. It takes careful planning and coordination because the designation of “custodial” parent not only affects the tax credit, but the usage of employer provided Flexible Spending Accounts (FSA).
Earned Income Credit: A tax benefit that helps lower to moderate earners; the benefit is substantially higher if you are the “custodial” parent.
This is only a sample of the tax issues that can arise related to children. Many attorneys are not aware of how to work within the limitations of the tax rules so my suggestion is that you and your spouse use a financial expert who is skilled in tax law to help you structure this.
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