The dependency exemption for minor children: when following the rules pays off.

• Author: Steinberg, Robert S.
• Position: Family Law

For the tax year that ended December 31,2011, slightly fewer than 84 million dependency exemptions (1) were claimed on returns for children living at home. (2) Subject to phase-out rules, (3) the child dependency exemption is a permissible deduction from taxable income (4) and entitles the claiming parent to other child-related potential tax-savers, such as head of household filing status, (5) childcare tax credit, (6) earned income tax credit, (7) exclusion for dependent care benefits, (8) and child tax credit. (9)

The exemption amount is annually adjusted for inflation. (10) For 2014 returns, the deduction amount was $3,950. (11) As of November 2014, the 2015 inflation adjustment and exemption amount had not yet been published by the 1RS. The exemption amount is phased out for high earners whose adjusted gross income exceeds applicable amounts, (12) which likewise are annually adjusted for inflation. (13) For 2014, the phase-out begins when adjusted gross income on a joint return exceeds $305,050, (14) $254,200 on a return filed by an unmarried individual, (15) and $152,525 on a married filing separately return. (16) On a joint return, the personal exemptions completely phase out when 2014 adjusted gross income reaches $427,550. (17)

With so many taxpayers claiming a child exemption, one would think that Congress would make the tax code addressing the exemption as simple as possible. However, it is anything but simple. Moreover, when a state court (18) order fails to follow the Internal Revenue Code, the complexity grows exponentially.

Like innocent spouse claims, disputes about which parent gets to deduct the dependency exemption for a qualifying child flows over from the family court into the Tax Court. (19) Usually, the tax owed in these disputes is small because high earners lose their dependent exemptions due to the phase-out rules. Low earners derive a smaller tax benefit because of graduated tax rates. The Tax Court, motivated to stay out of the fray, has required strict adherence to the rules of [section]152(e) for the noncustodial parent to claim the exemption.

This article describes the characteristics of a child that would qualify for a dependency exemption under the I.R.C., explains the parents' entitlement to claiming the exemption and the rules that must be followed for one parent to waive his or her rights, articulates the complexities that arise when a qualifying child's parents file their federal tax returns separately, discusses the Tax Court's treatment of state court order provisions relating to child dependency exemptions, and explores steps that can be taken to help maximize the possibility that the 1RS will honor a parent's entitlement or waiver of the right to claim a child as a dependent for federal tax purposes.

Qualifying Minor Children

Not every minor child qualifies to be claimed as a dependency exemption deduction on a federal tax return. The minor child must meet certain tests, namely: (20)

* Relationship Test--An eligible child may be a taxpayer's child, (21) grandchild, brother, sister, stepbrother, stepsister, or a descendent of any such relative. (22)

* Age Test--The child must be younger than the taxpayer, (23) must not have attained age 19 at the close of the taxable (24) year, or must be a student under age 24, (25) or must be permanently and totally disabled. (26) As stated above, however, a child over the age limits who meets other tests may be claimed as a qualifying relative dependent. (27)

* Support. Test--The child must not have provided more than one-half of his or her own support for the calendar year. In other words, others must have provided at least one-half of the child's support. (28)

* Household Test--The child must have had the same principal place of abode as the parents for more than one-half of the taxable year in which the dependency exemption is claimed. (29)

* Return Test--If married, the child must not have filed a joint return with his or her spouse (other than to claim a refund), for the taxable year in which the taxable year of the parents' return begins. (30)

* Citizenship Test--Even if a child meets all prior tests, he or she may still not qualify as a dependent for tax purposes unless he or she has been a citizen or resident of the U.S. or a country contiguous to the U.S. (31) at some time during the calendar year for which the exemption is claimed, (32) except as to an adopted child who has the same principal place of abode as the U.S. citizen parents and is a member of the parents' household. (33)

Entitlement to Claiming the Exemption

* Custodial Parents'Rights: The Fall Back Rule--When a qualifying child's parents file their federal tax returns separately, the 1RS will implement a two-step process to determine which parent is entitled to claim the child's dependency exemption. First, the parent with whom the child resided for the longest period of time during the taxable year (34) (the custodial parent (CP)) (35) is entitled to claim the child. If the child spends an equal amount of time with both parents, (36) the parent with the highest adjusted gross income for the year (37) is entitled to claim the child. This is called the fall back rule. The parents or a court may preempt the fall back rule if, pursuant to agreement or court order, a parent waives his or her right to the dependency exemption for a qualifying child.

* Noncustodial Parents' Rights--When noncohabiting parents file separate federal tax returns, generally, only the CP (38) will be entitled to claim a qualifying child as a dependent. (39) An exception to this rule exists under [section]152(e), which permits a noncustodial parent (NCP) to claim the exemption. For the exemption to apply, the child's parents must 1) together have provided more than one-half of the child's support during the calendar year, (40) and either be divorced or legally separated under a decree of divorce of separate maintenance, (41) be separated under a written separation agreement, (42) or live apart at all times during the last six months of the calendar year (43); and 2) together or separately have custody of the child for more than one-half of the calendar year. (44)

If the above conditions are satisfied, the NCP may claim the child as a dependent on his or her return without satisfying the previously discussed household test, (45) provided that:

the custodial parent signs a written declaration (in such manner and form as the [s]ecretary may by regulations prescribe) that such custodial parent will not claim such child as a dependent for any taxable year beginning in such calendar year, (46) and the noncustodial parent attaches such written declaration to the noncustodial parent's return for the taxable year beginning in such calendar year. (47)

These two requirements--the written declaration and the NCP attaching the written declaration to his or her federal tax return--are paramount to the successful claiming of the exemption as will be discussed.

Written Declaration of the Exemption Waiver: Form 8332

The written declaration of a parent's waiver of his or her right to claim a child dependency exemption may be made on Form 8332 (48) or in a separate writing that conforms to the substance of Form 8332 and "is executed for the sole purpose of serving as a written declaration under this section. An acceptable Form 8332 or equivalent must be attached to the return of the NCP. A court order or decree or a separation agreement may not service as a written declaration." (49) But, a court...