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Children of Divorced Parents

The "Working Families Tax Relief Act of 2004" ("WFTRA") made significant changes to the rules for determining dependency and other child-related tax issues. As always, some ambiguities still existed. Now there is at least one clarification made as a provision of (rider on?) the Gulf Opportunity Zone Act signed into law on December 21, 2005.

Divorce is never a pleasant experience, but it is particularly worse when children are involved. Often it also has a negative impact on the tax return.

Divorce settlements often stipulate tax issues. Unfortunately, the stipulation does not always agree with the law, and that create a difficult spot for the taxpayer who must either violate the court order or the tax law. In the end it is always the tax law that prevails, but an unpleasant process is guaranteed.

One very common stipulation in a divorce settlement is provisions for who may claim the dependent deduction for a child, and other tax related child issues. (One example might be where the court order indicates one parent may claim the dependency, but the other parent may claim a credit, such as the Child Tax Credit, that must always go with the dependency. Also realize that tax laws do change and what might have been fine when a judge issued a ruling may no longer be allowed. See below for additional clarification.) The WFTRA of 2004 made some changes that could affect the implementation of some of those decrees.

But there is one clarification made by the GO Zone Act of 2005 that will affect many taxpayers. In many cases a child lives with one parent, while the other parent is allowed to claim the child dependency. This is generally stipulated in the divorce settlement. For some time there has been confusion as to whether the divorce decrees is sufficient for this tax "exception". Now that is clarified: it is NOT.

For the parent to claim a child that does not live with them, they must have a signed Form 8332 that is attached to their return. The form is completed and signed by the parent with physical custody and provided to the claiming parent. One impact of this is that the claiming parent will no longer be able to E-File their return, since the attachment is required. (We expect a rectification to that.)

What happens if the custodial parent refuses to provide a completed Form 8332? Assuming the divorce settlement requires the cross-claiming, then the custodial parent would be in violation of the court order. We anticipate there is legal recourse for that, but such law is outside our expertise. The proper parent could claim the dependent without the form, with some potential problems. Technically that is an incorrect tax return, but could be sorted out when challenged by the IRS.

Update Sumer 2007: The IRS has issued Proposed Regulations that will clarify some of these procedure items a bit. It also will create a method to rescind a dependency release that had been granted indefinitely. But for now these rules are only proposed, meaning the IRS is accepting comments on them. We cannot predict if they will be made official, and with or without changes. But it is possible that we will have clarity beginning for the 2008 tax year.

For reference, see Section 404 of the Gulf Opportunity Zone Act (H.R.4440) of 2005. Bills may be found at the Library of Congress.

Clarification: Do not confuse the tie-breaking rules in the tax code with provisions of a court order. The tie-breaking rules are applied by the IRS when two (or more) taxpayers both claim the same person for a benefit. Those rules are not intended to supersede a court settlement. We anticipate that if a party to a divorce decree ignored the ruling of the court and claimed something belonging to the other parent, the IRS would use the tie-breaking rules and leave the injured parent to sue for damages. While not an attorney, it seems like a pretty easy case for the court to solve.

"Tax software is no substitute for tax knowledge."

Any views expressed herein are based on our best information. The content of this web site was written as general information without specific individual information and thus may not apply in all situations. This material was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

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Janelle Ogg, EA
Richard Ogg, EA