If a couple is to divorce with kids, tax issues and considerations include child support payments, dependency exemptions, tax credits and medical expense deductions.
Wise people know it is not the amount of money you earn, it is the amount you take home that matters. One way to increase your take home pay is to minimize the amount of taxable income you have. It is important to know what tax deductions and credits will apply to you after your divorce so you can calculate your net income and plan for the future accordingly.
Child Support and Tax Issues
Alimony payments are often deductible by the payor spouse. Child support payments are not.
Child support payments are never treated as gross income for the payee by the IRS. That means under no circumstances does the non-custodial spouse get a tax deduction for support, nor does the payee spouse have to pay taxes on the support received.
If you are paying child support as part of your divorce, treat the support as an expense.
Dependency Exemptions for Kids
Tax savvy parents recognize that the dependency exemption can be a valuable tax tool to reduce your amount of taxable income. A tax payer in 2012 could claim an exemption of $3800 for each qualifying child. That means each exemption reduces the amount of income that the government will tax by
But when parties split, and children spend time in multiple homes, the exemption becomes a valuable commodity for both parties. The problem is that only one parent can claim the dependency exemption for any child in any given year.
Tax Definition of Qualifying Child
According to the IRS, the definition of a qualifying child is an individual who:
1. Bears a relationship to the taxpayer,
2. Has the same principal place of abode as the tax payer for more than one half of the year,
3. Is not 19 at the beginning of the calendar year, or a student who has not turned 24 at the close
of the calendar year
4. Has not provided one half of his or her own support for the year,
5. Has not filed a joint return with the individual’s spouse for the calendar year,
Tax Issues and What It Means
For purposes of post-divorce planning, a qualifying child is a child of one of the parties of the applicable age who is still dependent on his parents. The custodial parent would qualify for the dependency exemption if this issue was not addressed in the divorce.
For tax purposes, the custodial parent is the parent that the child spends the majority of the overnights with during the year. In a divorce decree, the parent with more than 183 overnights would be the custodial parent.
If the parents both had an equal number of overnights, the parties would have to articulate in the divorce settlement agreement which parent would designated the custodial parent.
In other words, if a couple divorce with kids, tax issues not addressed in the divorce action will default to the majority timesharing parent being the parent that is entitled to claim the dependency exemption, because the IRS law would be controlling.
Assignment of Exemption for Kids
While it is true that the majority custodial parent will qualify for the exemption if the issue is not addressed, the custodial parent can release the exemption to the other parent if she wishes. Commonly, this is done as part of the marital settlement agreement and child support order.
In such cases, the parents may agree to rotate the dependency exemption on a yearly basis. Alternatively, in cases with multiple children, the parents will each take an exemption for a designated child every year.
In all of these cases, the parent releasing the exemption should fill our and file the IRS Form 8332 every year at tax time. Good drafting by the non-custodial parents divorce attorney will include explicit language requiring the non-custodial parent to fill out the 8332 form.
What if Both Parents Claim the Exemption
The IRS has anticipated this problem, and announced an easy rule to resolve such situations. If both parents claim the dependency exemption, then both parents lose the exemption, and an audit will be forthcoming.
It is best to play by the rules set forth in your divorce decree, or else as laid out by the IRS in statute.
“Tax Credits”: Child Care Expenses and Child Tax Credit
Unlike the dependency exemption above, there is no exception for the non-custodial parent when it comes to these tax credits. The custodial parent gets to claim these credits, and they cannot be released to the non-custodial parent.
50-50 timesharing: But what about when the parents rotate custody? In these cases, the parents would be advised to “pick” and define what parent will be the custodial parent for tax purposes in the parenting plan or settlement agreement. In such a case, the parents will want to adjust the net income used to calculate child support to bring equity to the parties.
The IRS allows a deduction for a parent when the child’s medical expenses exceeds 7.5% of gross income. This means it may be advantageous for one parent to pay all of the medical expenses in a given year for a particular qualifying child. Such a treatment of medical expenses requires two post-divorce parents that are willing to work together to achieve the best financial result for the entire family. In situations where the parents cannot work together, simply splitting the medical expenses by a defined percentage may be best.
It is important to understand, if you are to divorce with kids, Tax Issues in the future can effect the agreement you negotiate in the present. Be aware of these issues, and ask your attorney or tax professional to discuss these issues as they relate to your specific situation. The effect of you divorce agreement with children will last at least until your youngest child turns 18, requiring you to be fully informed while settling your case.
By Christian Denmon, Esq.