Rules Clarified for Claiming the Exemption (and Related Tax Breaks) for Children of Divorced Parents

New final rules clarify who may claim qualifying children in the case of divorced or separated parents. Treasury Decision 9408, amending Treas. Reg. § 1.152-4, clarified the “counting nights” rule to identify a custodial parent.

In promulgating the final regulations, the IRS took into consideration comments of the AICPA (Aug. 8, 2007) and other professional groups. Although the rules specifically address exemptions, tax practitioners need to be aware of implications for the child credit, child care deduction, earned income tax credit, and head of household filing status. Future income tax rebates will also be affected if they are worded similarly to the Economic Stimulus Act of 2008.

DETERMINING THE CUSTODIAL PARENT
Effective for tax years beginning after July 1, 2008, the exemption for a qualifying child of parents who are divorced, separated under a written separation agreement or who lived apart at all times during the last six months of the year goes to the custodial parent, regardless of what the divorce decree or written separation decree says, unless the noncustodial parent attaches a signed waiver effective for that tax year. The release of claim for an exemption must either be on Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, or a written declaration for the sole purpose of releasing the claim that conforms to the substance of Form 8332.

Where one or both parents have the right to physical custody for over one-half of the calendar year and the child is under the age of majority under state law, the parent with whom the child resides longer during the calendar year is the custodial parent. The child is deemed to reside with a parent using the counting-nights rule, where each night that a child (1) sleeps at the parent’s residence, whether or not the parent is present, or (2) sleeps in the company of the parent when the child does not sleep at a parent’s residence, such as when the parent and child are on vacation, is a night of residence for that particular parent. (In the case of a parent who works at night, a child resides with the parent based on greater number of days, not nights.)

REVOCATIONS OF RELEASE
A custodial parent has the right to revoke a previously signed release of claim by notifying the noncustodial parent in writing, using Form 8332 or a written document that conforms in substance to this form. Revocations cannot be retroactive; the earliest effective date for a revocation is the first calendar year after the custodial parent has reasonably attempted to notify the noncustodial parent. The revocation must be attached to the tax return of the parent revoking the release of claim for each year a revocation of a waiver is in effect and the qualifying child is claimed on the custodial parent’s return.

CHILD TAX CREDIT AND OTHER BREAKS FOLLOW
This regulation is important not only for the exemption deduction of $3,500 in 2008, but also for claiming the $1,000 per year child tax credit for each qualifying child under the age of 17. (Exemptions and child tax credits are subject to phaseouts for high-income taxpayers.) The child tax credit may also be claimed against alternative minimum tax and is refundable for certain low-income taxpayers. (For military service members, combat pay, which is normally exempt from gross income, is treated as earned income, often resulting in larger credits. Tax preparers also should review the HEART Act, enacted in June 2008, for additional military benefits.) Similarly, the HOPE scholarship and Lifetime Learning credits follow the exemption, not the custody of the child or the person paying the qualified education expenses. Currently, the maximum HOPE credit is $1,800 per student per year for the first two years of postsecondary education, and the maximum lifetime learning credit is $2,000 per student per year.

BOTH PARENTS CAN NOW CLAIM DEPENDENT FOR CERTAIN EXPENSES
In addition, the IRS in August issued Revenue Procedure 2008- 48, which allows both parents who are divorced or separated to exclude from gross income certain deductions and exclusions on behalf of a dependent child, even if the custodial parent has not released his or her claim of an exemption for the child under section 152(e). They are: the itemized deduction for unreimbursed medical expenses under section 213(a), employee-provided medical expense reimbursements under section 105(b), employer-provided coverage under an accident or health plan under section 106(a), distributions from health savings accounts and Archer medical savings accounts, and certain fringe benefits that qualify as no-additional-cost services or qualified employee discounts under section 132(a). The revenue procedure is effective Aug. 18, 2008, but taxpayers may apply it to prior tax years still within the limitations period as of that date.

By Valrie Chambers, CPA, Ph.D., associate professor of accounting, Texas A&M University–Corpus Christi. Her e-mail address is valrie.chambers@tamucc.edu.