Tax Planning for Divorcing Taxpayers with Children
By Josie Levesque
After a divorce, parents with children no longer file a joint return and must determine who is entitled to claim the children as dependents and the host of related tax credits and deductions available for taxpayers with children. These benefits, including the Child Tax Credit (CTC), head of household filing status, and the Earned Income Credit (EIC), can substantially reduce a parent’s tax liability.
The IRC establishes a framework to resolve child-related tax matters, primarily by designating one parent as the “custodial parent.” Generally, the custodial parent is the parent with whom the child resides for the greater number of nights during the year. This parent is automatically entitled to claim the child as a dependent, along with all related tax benefits.
The rules allow the custodial parent to choose to release the right to claim the dependents to the noncustodial parent by signing Form 8332 (Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent) which is then attached to the noncustodial parent tax return. A state divorce decree is not sufficient to transfer the dependency exemption for federal tax purposes. The form allows the release for the current year or for multiple years. The form is also used to revoke past releases starting with the tax year following the notice of revocation. Form 8332 should be one of the documents exchanged when the divorce becomes final.
Dividing the Benefits: What Transfers and What Stays?
The tax law creates two distinct baskets of child-related tax benefits. One basket is tied directly to the dependency, while the other is tied to custody.
When a custodial parent properly executes Form 8332, they release only the benefits tied to claiming the child as a dependent. The noncustodial parent who attaches this form to their return becomes eligible to claim—
- The Child Tax Credit (CTC) and Credit for Other Dependents (ODC): This allows the noncustodial parent to claim the per-child credit under IRC Sec. 24, subject to phase-out rules.
- Education Tax Credits: The noncustodial parent can claim the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit for the child’s qualified education expenses under IRC Sec. 25A.
- Student Loan Interest Deduction: A parent can deduct up to $2,500 of qualified student loan interest paid for a child they claim as a dependent under IRC Sec. 221.
Several of the most valuable tax benefits remain exclusively with the custodial parent, regardless of who claims the child as dependent. These benefits are tied to where the child lives, not who claims them on a tax return. The noncustodial parent can never claim the following:
- Head of Household Filing Status: This advantageous filing status is available only to the parent who maintains a household for the child for more than half the year.
- Earned Income Credit (EIC): The EIC is a refundable credit for low-to-moderate-income working individuals, and only the parent with whom the child resides for more than six months can claim it.
- Child and Dependent Care Credit: This credit, for expenses paid for the care of a qualifying individual to enable the parent to work, is only available to the custodial parent.
- Exclusion for Dependent Care Assistance Benefits: This allows for the tax-free receipt of employer-provided dependent care benefits.
Child’s Medical Expenses Exception
One exception relates to medical expenses. Under IRC Sec. 213(d)(5), a child of divorced parents is treated as a dependent of both parents for purposes of the medical expense deduction. This means either parent can deduct the medical expenses they personally pay for the child, regardless of who claims the dependency exemption.
