In a divorce, parents often dispute who gets custody of the child. The answer to that question can have serious personal and financial consequences. One of the often overlooked long term effects of this decision is on who gets to take the tax break for having the children.
The most important tax break a parent receives is the dependency exemption. This exemption allows a taxpayer to treat a portion of their income as non-taxable. The exemption for the 2013 tax year is $3,900 per child (and adult). But who gets to claim this exemption?
The general rule is that whichever parent has the child for the longest period of time in the tax year gets to claim the dependency exemption. This general rule does have one big caveat, the parents collectively must have custody of the child for more than six months of the year. If the combined days of custody for each parent is less than half of the year, neither parent can take the personal exemption because the child will not be considered a dependent. There are also other requirements for establishing that the child is your dependent that must be met, such as the child must be younger than 19 (or 24 if they are in college). For more information on whether a child is your dependent, see this IRS guide.
If you are a non-custodial parent, all is not lost. There is an exception to this rule which permits the custodial parent to give the exemption to the non-custodial parent. To pass the exemption, the parents must sign a written declaration giving the non-custodial parent the right to take the tax break. Prior to 2009 this written declaration could have been included in the divorce decree. Now, however, the IRS requires a separate document signed by both parents. The best practice is to fill out IRS form 8332 which will define the custodial and non-custodial parents’ rights.
To claim the exemption as a non-custodial parent, the non-custodial parent should include a copy of the signed 8332 or similar document for every year that you are claiming the exemption. The IRS will apply the exemption to the account with the submitted 8332 or similar document.
For all other tax breaks that you can get from having a child, such as an earned income credit, only the custodial parent may receive that credit. Only the dependency exemption can be passed to the non-custodial parent.