Before 2018, listing a dependent child on the federal tax return meant a per person exemption resulting in paying less federal taxes. From 2018 to 2025 the dependency exemption is suspended. For now, the issue of child dependency is still relevant but more complicated.
Let’s begin with a scenario: a married couple with two minor children separate in April 2020, and are now getting ready to file 2020 income taxes and plan to file separately. They don’t know who gets the child tax credit and other benefits when both of the children are dependents. Is it fair for each to take one dependent child? Does the splitting of dependents save the most in taxes? If one parent has served as the primary custodian since separation, how will this affect the decision?
A child is a dependent under the following criteria:
- the child is under the age of 18 at the end of the tax year for which the return is being filed
- the child lived with the parent(s) for over half of the given tax filing year
The latter of these criteria is called the residency test. When parents are separated it’s not unusual that one parent will be the primary custodian, in other words that parent maintained physical custody of the child for over 50% of the year. Thus, the primary custodian is entitled to take a dependency exemption for the child.
Exceptions to the Child Residency Test
There are certain exceptions to this residency test which allow for the non-primary physical custodial parent to take a dependency exemption. The non-primary physical custodian, or non-custodial parent for tax purposes, may be able to declare a child as a dependent if they are a member of one of three groups:
- already divorced (keep in mind that Pennsylvania does not have a decree of separation which IRS will consider in other states)
- the couple has signed a separation agreement
- if the couple was never married they have been separated from July to December of the tax year
For the non-custodial parent to list the child as a dependent these rules apply:
- the child must have received over 50% of her or his support from the parents
- the child must have been in the custody of one or both parents for over 50% of the year
- the custodial parent (the one who had custody more than the other parent) must sign a proper release that the custodial parent will not claim the child as a dependent and that release is attached to the non-custodial parent’s tax return.
While the federal tax regulations (Section 152-4) give a variety of examples of the proper form of a release or revocation of a release, the simplest form, that cannot be questioned is Internal Revenue Code Form 8332. It’s important that the parents understand a handshake agreement about this issue won’t survive an IRS audit.
Negotiating for a dependency deduction
When deciding whether to negotiate for a dependency deduction as a non-custodial parent, one should consider the value to them individually and collectively. It makes sense to minimize taxes, thereby maximizing funds available to support the child(ren). When the dependency exemption was suspended for 2018-2025, the IRS provided for a number of tax benefits related to dependents, including the child tax credit. The child tax credit is worth up to $2,000 per dependent child. For a low income parent, if that parent has little or no tax liabilities, up to $1,400 per child is refunded to the parent. Although in the past a couple would split the dependency exemptions, now the parents should more carefully consider the income level of each parent because the higher income parent may earn too much money to get the entire child tax credit. The IRS provides a formula for the decline in the tax credit based on the income of the parent.
Other Child Tax Credits
In addition to the child tax credit, there are other tax credits linked to a dependent child. The CARES Act, initially passed in response to the COVID-19 pandemic and more recently supplemented, resulted in the distribution of stimulus checks in March and December, a portion of which was directly linked to the claim of a dependent child on the 2019 tax return who qualified for the Child Tax Credit. Since the stimulus checks issued in 2020 were based on a lookback to prior tax returns, some parents are now eligible to file separately in 2020 with lower taxable income, and will claim a dependent child for the first time. The parents will be able to apply for the child tax credit on their 2020 return, and if in fact the stimulus check did not issue to that parent they may be eligible to claim the Recovery Rebate Credit.
Putting emotions aside and doing what is right for the children
For many couples the prospect of negotiating or litigating over these matters is overwhelming and often the financial benefit is outweighed by the aggravation and cost of legal and accounting fees to get to the accurate results. Here are suggestions for parents who want to minimize the aggravation and do what is right for their children:
- Ask their tax preparer(s) to crunch the numbers splitting or shifting the dependents from one parent to the other and compare the results.
- If the loss of a dependent means money out of pocket for the parent who owes taxes, the tax credit enjoyed by the other parent could be shared to soften the blow.
- If payments like the stimulus checks of 2020 continue in some form, discuss in advance whether funds will be shared by the parties or how funds will be utilized. The parents are encouraged to primarily view these payments as funds to support the children. If they are already able to support their children, funds could be saved for the future benefit of the children.
It is the responsibility of tax advisors and legal counsel to lay out the options. It is a smart parent who will put emotions aside, take steps to pay only the taxes required, and make sure the financial relief is used for the benefit of their children.