Tip of the Month:
Impact of Claiming Child Dependency Exemption on Use of Other Tax Credits

In the November, 2002, Divorce Tax Tips Newsletter, the importance of combining the tax savings from the Under Age 17 Child Tax Credit ($600 per child) and the Child Dependency Exemption was highlighted. This is important because the tax laws have linked the Under Age 17 Child Tax Credit to who actually claims the child dependency exemption on the tax return. There are instances when relinquishing the child dependency exemption (and child tax credit) to the non-custodial parent will make tax sense. In those instances the IRS Form 8332 must be used.

Child Care and Earned Income Credits
If your case facts indicate that more tax will be saved by the non-custodial parent claiming the child dependency exemption for taxes, there may be questions on how this decision impacts the claiming of other tax credits. The other major tax credits in divorce analysis are the Child Care Credit and the Earned Income Credit (EIC) when the children are younger and the education credits when the children are older.

The confusion stems from the definition of “Qualifying Child” for the various credits. For example, the initial test to qualify for the child care credit is that a qualifying person is “Your dependent who was under age 13 when the care was provided and for whom you can claim an exemption (dependency)”.

Does this mean that if the child dependency exemption is relinquished to the non-custodial parent, then the custodial parent cannot claim the child care credit?

The answer is NO – the custodial parent is the only one who can claim the child care credit.

The child care credit can only be claimed by the custodial parent and payments by a non-custodial parent will not qualify for the child care credit. The custodial parent can continue to claim the child care credit and this is clearly enumerated in the IRS publication “Child and Dependent Care Expenses – Publication 503 for 2002”. The following is a direct quote from that publication.

“Child of Divorced or Separated Parents
To be a qualifying person, your child usually must be your dependent for whom you can claim an exemption. But an exception may apply if you are divorced or separated. Under the exception, if you are the custodial parent, you can treat your child as a qualifying person even if you cannot claim the child’s exemption. If you are the non-custodial parent, you cannot treat your child as a qualifying person even if you can claim the child’s exemption.” (page 4).

For tax law, physical custody for the greater part of the year is the key factor in determining who can claim the child care credit and the earned income credit (EIC has other rules which may not allow a custodial parent who has moved back in with her parents to claim the EIC). In fact, the relinquishing of the child dependency exemption to the non-custodial parent has no impact on either the child care credit or the earned income credit. These two credits can only be claimed by the “custodial” parent. However it does have an impact on the under age 17 child tax credit and this is linked to who is actually claiming the child dependency exemption on the tax return.

Education Credits
The Hope Credit ($1,500 per child for the 1st two years of college) and the Lifetime Learning Credit follow the same rule as the Under Age 17 Child Tax Credit in that the actual claiming of the dependency exemption is necessary to be able to claim these education credits. So watch the language in your divorce agreements to ensure that in cases when the child dependency exemption has been relinquished to the non-custodial parent for years when the child is younger, that the claiming of the child dependency exemption will revert back to the custodial parent when the child is older and in college. The Education Credits have income tests associated with them and can be very valuable to former spouses who have income under $50,000 per year but only if the child dependency exemption is actually claimed by that parent. Physical custody does not override the claiming of the dependency exemption for the education credits.