It’s that Taxing Time of Year, Part I

“Who should claim a child?”

According to the IRS, the parent who can claim the dependency exemption for a child on his or her tax return is the one designated the custodial parent by court order or agreement. When there is no such order or agreement, the custodial parent is defined as the parent with whom the child resides for the greater number of nights during the year. But giving that parent the exemption is not always a good idea. Here’s why.

For the 2010 tax year the dependency exemption for a child was $3,650. This allows the parent who claims that child as an exemption to reduce his or her income by that amount. If a parent is in the 15% tax bracket (income of $8,375 to $34,000) his or her tax savings is about $550.00 while a parent in the 25% bracket (income of $34,000 to $82,400) saves about $910.00. By allowing the parent in the higher tax bracket to claim the child as an exemption this couple can save over $360 per child per year in taxes! And if the parent with the higher income is in the 28%, 33% or 35% bracket the tax savings is even greater.*

While some couples alternate who claims the child from year to year in order to share the tax benefit, it usually makes more sense to award the exemption to the parent who would receive the greatest tax benefit, even if it means that he or she pays the other parent his or her “tax cost”, which would be about $550.00 in the example above.

In order for the custodial parent to release the exemption to the non-custodial parent, the custodial parent must execute IRS Form 8332 which the non-custodial parent then files with his or her tax return. Many custodial parents require the non-custodial parent to pay his or her tax cost at the time they sign and provide this form.

The major problem with sharing the tax benefit is that it requires the two parents to share income and tax information with each other every year and some couples are not able or willing to do that. However, if you were able to work together to create an agreement that works well for both of you, as most couples do in divorce mediation, you can save thousands of tax dollars during the years you are raising your children. It might well be worth the effort.

*For more information on tax rates and income brackets see http://www.efile.com/tax-service/tax-calculator/tax-brackets