IRS Defines Custodial Parent for Tax Purposes
Broken hearts and a bad ending to a fairy tale – that’s divorce. It’s hard enough to duke out who gets what, but fussing over who gets to claim the kids can be agonizing.
Most parents walk away from divorce settlements thinking they have everything figured out. Sadly, many are unaware that the divorce court deciding their civil differences, had no jurisdiction over tax matters. When the logistics of custody are outlined in the divorce decree, the custodial parent for tax purposes is determined by IRS rules.
Yes, federal law will trump civil law every time. IRS rules don’t depend on what the custody agreement states. This creates certain confusion at tax time. According to the IRS, the custodial parent is the parent who the child spent the most number of nights with during the past tax year. Only the custodial parent may then claim the child as a tax dependent.
An exception does apply when parents agree to alternate the dependency deduction from year to year. For this to carry any weight on IRS terms, the custodial parent must sign Form 8332, waiving their right to the dependency deduction and the noncustodial parent attaches it to their tax return. Noncustodial parents would be wise to obtain this signed waiver as a part of the divorce settlement. More importantly, attaching it to the tax return each year the exemption is claimed is an absolute must!
What happens with joint custody and a child that splits their time equally between the parents? For tax purposes, the IRS has tiebreaker rules shedding any doubt to who is the custodial parent when the question arises. According to the IRS, the parent with the highest adjusted gross income is the custodial parent for tax purposes when children split their time 50/50 among both parents.
Numerous tax benefits are given to the custodial parent highlighting the importance of the distinction from noncustodial parent. The custodial parent is the only parent eligible for certain tax benefits, such as head of household status, earned income tax credit, and child and dependent tax credits. Said another way, the noncustodial parent is never allowed to claim those tax benefits – even if the custodial parent doesn’t claim them.
Further tax benefits exist for any parent claiming a child, but the custodial parent must waive their rights to claiming them by completing Form 8332. The only tax benefits transferable to the non-custodial parent are the dependency exemption deduction, child tax credit, education tax credit/deductions, and the student loan interest deduction. The value of these tax benefits are generally worth more than the dependency exemption itself.
Don’t get divorced until the kids grow up. Since that’s unrealistic, if Form 8332 is not signed by the custodial parent and attached to the non-custodial parent’s return, that parent is in jeopardy of losing if the issue ends up in IRS hands, or worse, Tax Court hands. Otherwise, an unfair disallowance or ruling from Tax Court could be their demise.
The Watson CPA Group is not a group of tax preparers or number crunchers- we are tax and business consultants, and our firm will take you through the cycles of your personal and business lives. Many accountants are only compliance oriented- and while IRS compliance is critical, being proactive is equally important.