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Introduction:
Monthly Divorce Tax Tips will draw on Dennis' practical divorce
planning experiences. Each month's Tax Tip will focus on a particular
item that family law practitioners may find useful. Emphasis will
be on making divorce tax issues understandable to family lawyers
and to show how to create opportunities to reduce joint taxes of
the parties as part of divorce settlements. Information on FinPlan
software as well as a complete HELP manual for answering divorce
tax questions are available at www.divorceplanner.com.
Dennis can be reached at FinPlan Co. 1-800-777-2108.
Tip
of the Month:
Who Should Claim the Kids
Introduction
Many times divorcing parents will spend an inordinate amount of
time (yours and theirs) arguing over who should claim the child
dependency exemption. This time may be very disproportionate to
the actual tax savings in question. This Tax Tip reviews the basic
concepts in understanding numbers and is the first in a series of
Monthly Tax Tips.
Child
Dependency Exemption
The Child Dependency Exemption is an allowed deduction for the
custodial parent. The exemption can be relinquished to the
non-custodial parent as part of a divorce settlement and this
transfer can be for one year or for several years. (IRS
Form 8332).
Tax
Savings from the child dependency are measured by applying the
tax rate or rates for a person to the allowed deduction of $3,000.
For example, if a person is in the 30% tax bracket, the $3,000 deduction
for the child dependency exemption will be worth $900 compared to
a person in a 15% tax bracket where this would be worth $450. At
higher income levels the tax savings are phased out - Single filing
status phaseout starts at $137,300 of Adjusted Gross Income and
Head of Household phaseout starts at $171,600. In the past, the
child dependency exemption was generally allocated to the parent
with the higher income (usually non-custodial) to reduce the joint
tax savings of the parties and the custodial parent was compensated
with spousal support (alimony) or some other financial part of the
divorce settlement.
Under
Age 17 Child Tax Credit
With the passage of the Under Age 17 Child Tax Credit, the old
rules for "Who Claims the Kids" have been turned
upside down. The Under 17 Child Tax Cr is linked to the dependency
exemption - whoever claims the dependency exemption must also
take the Under 17 credit whether they can use the credit or not.
This credit is now worth $600 and is also partially refundable for
low income individuals who cannot make use of the credit because
they do not pay enough tax (remember non-refundable tax credits
are only good if you pay more tax than the credit amount). The $600
credit is also phased out as income increases (over $75,000 of Adjusted
Gross Income) but the phaseout is much faster than for the dependency
exemption phaseout. The Under 17 Child Tax Cr is easy to compute
(generally $600) but it can be difficult to determine if it can
be used in low income cases. This credit is now partially refundable.
10% of earned income over 10,350 is a refundable credit if the regular
tax calculation does not permit use of the Under 17 Child Tax Credit.
Tax
Tips
1. Because the under 17 credit is linked to the dependency exemption,
you should combine the tax savings from the child dependency
exemption with the under 17 child tax credit to determine who
saves the most tax from claiming the child dependency exemption.
2.
You should evaluate who should claim the children after you have
established an initial spousal support amount because spousal
support (alimony) can impact your decision by changing the under
17 child care tax amount actually used.
3.
If your analysis indicates that tax savings would be greater if
the non-custodial parent claims the children, you will have to increase
the spousal support to allow the custodial parent to get back
to the level of after-tax cash you determined was appropriate before
you switched the dependency exemption to the non-custodial parent.
Example:
Assumptions: Custodial makes $90,000 and Non-Custodial makes $30,000
Tax
Savings from Claiming 1 Child Dependency Exemption
| No
Alimony Case |
Non-Custodial |
Custodial |
| Dependency
Exemption |
$
900 |
$
450 |
| Under
17 Child Tax Cr |
0 |
600 |
| Total
Tax Savings |
$
900 |
$1,050 |
|
|
|
| With
$12,000 of Alimony |
|
|
| Dependency
Exemption |
$
810 |
$
450 |
| Under
17 Child Tax Cr |
600 |
600 |
| Total
Tax Savings |
$1,410 |
$1,050 |
Note:
In Alimony case, tax rate of non-custodial drops from 30% to 27%.
Next Few Tips
Tax
perspective of end-of-year divorces - should couple get divorced
in December or January? Using the Dependency Exemption & Under 17
Tax Cr to save lower income divorcing couples thousands of dollars
per year - complex number crunching because the credit may not be
able to be fully used by custodial parent due to insufficient tax
of a low income individual. Impact of claiming dependency exemptions
on use of other credits.
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