Finances and taxes are a significant issue during divorce, especially when children are involved. There are also special rules in the tax code that govern divorce and separation. It’s important to be apprised of these rules.
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Dependency Exemption. If you are the custodial parent of the children, you can claim a dependent exemption of $3,950 (for 2014) for each child. The noncustodial parent may claim the dependent exemption and the child tax credit for the children with the consent of the custodial parent. For this change to be valid, the custodial parent must sign IRS Form 8332 Release of Claim to Exemption for Child of Divorced or Separated Parents. The noncustodial parent must attach the signed release to his or her income tax return each year for which the dependency exemption is claimed.
Even if the noncustodial parent takes the exemption, the parent who has custody of the child can still claim Head of Household filing status, which results in a lower tax liability. The custodial parent may also qualify for the Child Care Credit, Exclusion for child Care Benefits and the Earned Income Credit. So, all is not lost if giving up the exemption credit.
Sometimes the parent who is not entitled to the exemption will attempt to take it anyway. In my tax practice, I see this happen every year. An electronically filed tax return is rejected because the dependency exemption has already been claimed. Resolving this issue is a long process, involving letters to the IRS with proof of the claim such as a statement in the Marital Separation Agreement (MSA). Or in the case where no MSA exists, the parent making the claim must provide proof of residency and of having provided more than 50% of the child’s support in order for the IRS to adjust the tax returns in his or her favor.
If you suspect your former spouse may try to hijack the exemption, my best advice is file early, file first.
Child Support. There are no tax issues revolving around child support. This is because child support is not deductible to the person paying it nor is it taxable income to the recipient. It doesn’t go on the tax return but it may be an element that comes into play when determining support issues for claiming the dependency exemption.
Alimony. Alimony however, is includible in income and is taxed at ordinary income tax rates. The party paying alimony may take it as a deduction. It’s listed an adjustment to income on Line 31a on Form 1040. Note that you must provide the social security number of your former spouse on Line 31b. This is because the IRS checks to ensure that the recipient is declaring the alimony income. There is also a match up to ensure that the amount claimed as a deduction matches what is claimed as income on the other party’s income tax return. If the numbers don’t match, someone is likely to get audited!
When you consider how much Uncle Sam gets from every paycheck, it becomes even more important to structure the elements of the divorce settlement in such a manner that benefits all parties. Therefore, one should consult with a tax professional as well as the attorney when filing for divorce.