The Tax Cuts and Jobs Act of 2018 made significant changes to the Tax Code, including child-related tax issues. If you are going through a divorce, be sure that your family law attorney is aware of Dependent Exemptions, Head of Household, Dependent Care Credit, Child Tax Credit, and Higher Education Tax Credits to ensure that you are properly represented during divorce. Merely addressing these issues in a divorce decree is not enough because rarely does the Tax Code respect the provisions of the divorce decree. Instead, you must ensure that you have taken the necessary steps to meet the requirements in the Tax Code. This article will help you understand the basics of each child-related tax issue to help you make sure that you do not leave money on the table while finalizing your divorce
2018-2025 - Dependent Exemption Eliminated
I.R.C. § 151(d)(5) was amended by the Tax Cuts and Jobs Act to provide for a zero exemption for taxable years beginning after December 31, 2017, and before January 1, 2026.
2026 and beyond – Dependent Exemption Revived (?)
Assuming no later amendment, the dependency exemption rules will revert to pre-2018 rules, with the 2018 personal exemption set at $4,150 and adjusted for inflation in future years. Counsel negotiating a divorce settlement involving minor children should take care not to allocate the exemptions to a higher income parent who will lose all or part of the benefit if adjusted gross income exceeds the threshold level.
An individual taxpayer is allowed one personal exemption for each qualifying child. I.R.C. § 152(a). A qualifying child is an individual who satisfies the following conditions
1. Relationship. The individual must bear a qualifying child relationship to the taxpayer. I.R.C. § 152(c)(1)(A); Prop. Reg. § 1.152-2(b). The necessary relationship exists if the individual is a child of the taxpayer; a descendent of a child of the taxpayer; a brother, sister, stepbrother, or stepsister of the taxpayer; or a descendant of a brother, sister, stepbrother, or stepsister of the taxpayer. I.R.C. § 152(c)(2).
2. Residency. The individual must have the same principal place of abode as does the taxpayer for more than one-half of the tax year. I.R.C. § 152(c)(1)(B); Prop. Reg. § 1.152-2(c).
3. Age. The individual must meet the age requirements. I.R.C. § 152(c)(1)(C); Prop. Reg. § 1.152-2(d). The age requirement is met if the individual satisfies once of three tests: (1) individual has not attained the age of 19 as of the close of the calendar year in which the tax year of the taxpayer begins; (2) the individual is a student who has not attained the age of 24 as of the close of the calendar year in which the tax year of the taxpayer begins; or (3) the individual is permanently and totally disabled at any time during the calendar year in which the tax year of the taxpayer begins. I.R.C. § 152(c)(3).
4. Dependent. The individual must not have provided more than one-half of his or her own support for the calendar year in which the tax year of the taxpayer begins. I.R.C. § 152(c)(1)(D); Prop. Reg. § 1.152-2(e).
5. Child must not file joint return. For tax years beginning after 2008, the individual must not file a joint return, other than a joint return filed solely as a claim for refund of estimated or withheld taxes, with the individual's spouse for the tax year beginning in the calendar year in which the tax year of the taxpayer begins. I.R.C. § 152(c)(1)(E); Prop. Reg. § 1.152-2(f).
If an individual is a qualifying child of two or more taxpayers, the following tiebreaker rules apply:
- If the taxpayers who claim the child are parents of the child and the parents do not file a joint return, then the parent with whom the child lived for the longer portion of the year is entitled to the exemption.
- If the taxpayers who claim the child are parents of the child, the parents do not file a joint return, and the child lived with each one for an equal amount of time during the year, then the parent with the highest adjusted gross income (AGI) for the year is entitled to the exemption.
- If only one of the taxpayers who can claim the child is a parent of the child, then the claiming parent is entitled to the exemption.
- If one or more parents can claim the child but do not, and two or more non-parent taxpayers can claim the child, then the non-parent taxpayer with the highest AGI for the year is entitled to the exemption if his or her AGI is higher than the highest AGI of any parent who can claim the child.
- If no parent can claim the child but two or more non-parent taxpayers can claim the child, the taxpayer with the highest AGI is entitled to the exemption.
Prop. Reg. § 1.152-2(g)(1).
Special Rules for Divorced or Separated Parents
Special rules determine which parent is entitled to claim the deduction when the parents are divorced or separated and filing separate returns. These rules allocating the deduction between divorced or separated parents do not apply unless the child is a qualifying child under the general rules described above.
The custodial parent is awarded the personal exemption if the following conditions are met:
- The child receives more than one-half of his or her support from both parents;
- The child is in the custody of one or both of the parents for more than half of the calendar year; and
- The parents are divorced or legally separated un a divorce decree or decree of separate maintenance; separated under a written separation agreement; or the parents were living apart at all times during the last six months of the calendar year.
I.R.C. § 152(e).
A noncustodial parent is only entitled to claim a qualifying child if the custodial parent signs a written declaration (e.g. IRS Form 8332) that he or she will not claim the child as a dependent for any tax year beginning in that year, and the noncustodial parent attaches the written declaration to his or her return for the tax year beginning during that calendar year. I.R.C. § 152(e)(2).
Under the regulations, the custodial parent is the one with whom the child resides for the greater number of nights during the calendar year, regardless of legal custody. Treas. Reg. § 1.152-4(d). The regulations further provide that, if a child is temporarily absent from a parent's home for a night, the child is treated as residing with the parent with whom the child would have resided for the night. However, if the child resides with neither parent for a night, the child would be treated as not residing with either parent for that night if it cannot be determined with which parent the child would have resided or if the child would not have resided with either parent for the night. In the case of a parent who works at night, the regulations provide that if, in a calendar year, due to a parent's nighttime work schedule, a child resides for a greater number of days but not nights with the parent who works at night, that parent is treated as the custodial parent. The regulations provide a tie-breaking rule — if a child resides with each parent for an equal number of nights during the calendar year, the parent with the higher adjusted gross income for the calendar year is treated as the custodial parent.
Releasing Claim to Exemption
A child will be treated as the qualifying child of the noncustodial parent (if the parents provide more than one-half of the child's support) if: (i) the custodial parent signs a written declaration “in such manner and form as the Secretary may by regulations prescribe” that he or she will not claim the child as a dependent for any tax year beginning in such calendar year, and (2) the noncustodial parent attaches the declaration to his tax return for the year. I.R.C. § 152(e)(2)(A). If the custodial parent does not release his or her claim to the dependency exemption, I.R.C. § 152(e) does not apply, and, generally, only the taxpayer who may claim the child as a dependent under I.R.C. § 152(c) (qualifying child described above) may treat the child as a dependent.
Under Treas. Reg. §1.152-4(e)(1), the dependent exemption deduction may be relinquished for a single year, a number of specified years (e.g., alternate years), or for all future years, depending on the wording of the declaration. The regulations also require that the written declaration include an unconditional statement that the custodial parent will not claim the child as a dependent for the specified year or years. Under the regulations, a statement is not unconditional if it expressly conditions the custodial parent's waiver as dependent on the noncustodial parent's meeting an obligation (e.g., payment of support). The written declaration must specify the year or years for which the release is effective. A written declaration specifying all future years is treated as specifying the first tax year after the tax year of execution and all subsequent tax years.
The written declaration may be made on IRS Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent or any successor form. An alternative form may be used, but it must conform to the substance specified for Form 8332 and it must be executed for the sole purpose of serving as a written declaration to release the claim to the dependency exemption. A court order or decree cannot serve as the written declaration. Treas. Reg. § 1.152-4(e)(1)(ii).
To provide certainty, regulations proposed in 2017 would provide that a written declaration by the custodial parent releasing claim to the dependency exemption attached to an amended return or provided during examination is ineffective if the custodial parent signed it after claiming the dependency exemption and has not filed an amended return to remove that claim to the dependency exemption. Prop. Reg. § 1.152-5(e)(2).
Head of Household Filing Status
The Tax Code imposes a tax on the taxable income of individuals. The rate of tax depends on the taxpayer's filing status. There are four filing categories for individual taxpayers: (1) married filing a joint return; (2) unmarried head of household; (3) unmarried individual (other than certain surviving spouses and heads of household); and (4) married filing a separate return. Tax rates are lowest for married individuals filing jointly and they progressively increase for each category in the following order: head of household, individual, married filing separately. If a taxpayer is unmarried, he or she must file as a single taxpayer unless he or she meets the requirements for filing as head of household, which has lower marginal rates.
Head of household status has two primary benefits: (1) the rates are lower than filing as an unmarried individual, and (2) the standard deduction is larger than unmarried taxpayers ($18,000 for head of household in 2018 versus $12,000 for unmarried individual).
The taxpayer must meet the following requirements to file as head of household:
1. Be unmarried as treated as unmarried under I.R.C. § 7703(b) on the last day of the tax year (and must not be a surviving spouse);
2. Maintain for more than half the tax year a home constituting the principal residence of a qualified person; and
3. Pay more than half of the expenses of maintaining that home. I.R.C. § 2(b).
Dependent Care Credit
The Tax Code allows certain taxpayers to claim a tax credit equal to a specified percentage of certain employment-related expenses incurred in caring for “qualifying individuals.” Qualifying individuals are limited to certain dependents of the taxpayer and include a taxpayer's child who is under age 13 or incapable of self-care and who has the same principal place of abode as the taxpayer for more than one-half of the tax year. I.R.C. § 21.
In the case of divorced and separated parents, the custodial parent is treated as the taxpayer eligible to claim the credit. I.R.C. § 21(e)(5). The parent treated as the noncustodial parent (described above) will not be eligible to claim a dependent care credit, even if he or she incurs qualified employment-related expenses. Note that unlike dependency exemptions, the Tax Code does not allow a custodial parent to release the dependency exemption for purposes of the dependent care credit to the noncustodial parent. If a settlement agreement is to provide for 50-50 shared physical custody and for alternating the dependency exemption and dependent care credit between the parents from year to year, the agreement should identify which parent is the custodial parent for tax purposes. For example, it should state that the party who is entitled to claim the exemption for any year will be the custodial parent for that year or, alternatively, that the parent who is not entitled to claim the exemption will be the custodial parent.
Child Tax Credit
The Tax Code provides a tax credit (up to $2,000 in 2018) for certain taxpayers with qualifying school-age children. Generally, the credit is a statutorily referenced amount for each qualifying child, although the amount of the allowable credit is phased out for taxpayers above certain income levels and subject to adjustments for taxpayers with three or more children.
The taxpayer must meet the following requirements to claim a child tax credit:
- The child must be a qualifying child; and
A child is a qualifying child if:
- The child is the child of the taxpayer or a descendant of such a child or a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of any such relative;
- The child has the same principal place of abode as the taxpayer for more than one-half the tax year for which the credit is being claimed;
- The child is under age 17;
- The child does not provide over one-half of such child's own support for the relevant tax year; and
- If the child is married, he or she does not file a joint return (other than solely to claim a refund) for the tax year. I.R.C. § 24(c)(1).
- The taxpayer must be eligible to claim the child as a dependent.
The child tax credit is refundable to the extent of 15% of the taxpayer's earned income in excess of $3,000. Taxpayers with three or more qualifying children are allowed a refundable child tax credit in the amount by which the taxpayer's social security taxes exceed the taxpayer's earned income credit, if that amount is greater than the refundable credit based on the taxpayer's earned income in excess of the inflation-adjusted amount referenced above.
The child tax credit follows the dependency exemption. The parties could inadvertently lose all or a part of the benefit of the child tax credit if the dependency exemption, and, thus, the child tax credit, is shifted to or retained by a parent with AGI in excess of child tax credit phase-out levels. AGI thresholds for phase out of personal exemptions are quite a bit higher than the child tax credit AGI thresholds.
The income threshold to claim the credit has been lowered to $2,500 per family. This means a family must earn a minimum of $2,500 to claim the credit. The income threshold at which the child tax credit begins to phase out is increased to $200,000, or $400,000 if married filing jointly. This means that more families with children younger than 17 qualify for the larger credit.
Higher Education Tax Credits
There are two credits for parents of college-aged children:
- American Opportunity Tax Credit - this is a credit for qualified education expenses, limited to first four years of higher education - up to $2,500 credit per eligible student (up to $1,000 is refundable)
- Lifetime Learning Credit - this is a credit for qualified tuition and related expenses for an eligible student, with no limit on years – up to $2,000 credit per tax return (not refundable)
Both credits require that the parent be eligible to claim the child as a dependent (see test above under Dependent Exemptions).