When parents divorce without a meeting of the minds or a well-crafted agreement, issues can result as to who is entitled to the tax benefits from supporting their children.
Sec. 152 includes what seems like a simple rule. Basically, where parents of a child do not file a joint return, the child is the "qualifying child" of the "parent with whom the child resided for the longest period of time during" the tax year. If both parents meet this rule, the parent with the highest adjusted gross income claims the child as a dependent (assuming all other requirements, such as age, are satisfied) (Sec. 152(c)(4)).
The law can become complicated for parents not filing a joint return because they are divorced, due to the existence of Sec. 152(e). The simple rule becomes complicated as Congress provides exceptions for divorced parents. This special rule constitutes 20% of the words of Sec. 152. The two exceptions are (1) the custodial parent releases his/her claim to the dependency exemption and (2) qualified pre-1985 instruments.
The second exception is likely "deadwood" today as any children mentioned in an instrument executed before 1985 are too old today to be minors. The first exception typically generates a few Tax Court decisions annually. This article summarizes these cases for 2016 (through September). There are lessons to be learned from these cases for parents, tax practitioners, and divorce attorneys, and they are noted here.
Signed Form 8332 is critical
In He, T.C. Summ. 2016-4, the parents divorced in 2010. They executed a Permanent Parenting Plan with a provision under which, if the husband (H) was current with child support payments, the wife (W), who had custody, would provide a signed Form 8322, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, by Feb. 15, to release the dependency exemption for their two children. Although H was current with child support, W refused to sign Form 8332. H claimed the children anyway (dependency exemption and child tax credit). H attached a letter to the return explaining the situation and attached the relevant pages of the divorce agreement. The IRS denied these tax preferences, and the court agreed.
According to the court: "Unfortunately for [H], the regulations explicitly state that court orders, decrees, and separation agreements executed in a tax year beginning after July 2, 2008, do not satisfy the written declaration requirement. [Regs.] Sec. 1.152-4(e)(1)(ii)(5) . . . [H's] divorce documents therefore may not qualify as a written declaration because they were executed after July 2, 2008, and, consequently, [H] failed to satisfy the written declaration requirement of section 152."
The court added that it sympathized with H but that it must follow the law as written.
Lesson learned: Avoid divorce agreement provisions that cannot be enforced (such as requiring one spouse to sign a Form 8332 every year). Regs. Sec. 1.152-4(e)(1) provides that the written declaration for the custodial parent to release the exemption can specify all future years. Such a release is treated as applying to the first tax year after the tax year of execution and all subsequent tax years. This should have been executed by the parents; however, it is not a guarantee for the noncustodial parent because a custodial parent can revoke the Form 8332, using a procedure discussed in the following Chief Counsel Advice, yet another Form 8332 development for 2016.
Form 8332 for future years
CCA 201602009 addressed the dependency exemption for divorced parents with two children who resided with the mother. Both parents claimed the children as dependents with the father claiming them per Form 8332. Part II of the form had the words "all future years" written on it, and Part I was blank. The mother did not recall executing the form and believed she never would have released the exemption for all future years.
The IRS noted that Regs. Sec. 1.152-4(e)(1)(ii) allows Form 8332 to be executed for all future years beginning with the years following the tax year of execution. The IRS also stated it was permissible for Part I not to be completed.
Thus, the IRS concluded that the father was correct in claiming the children. According to the IRS, "[i]f the custodial parent did not execute the Form 8332, her remedy is against the noncustodial parent." Should the mother want to revoke the release to claim the dependency exemptions, she may do so for the first year after the year of revocation. Part III of Form 8332 is used for this purpose.
Lessons learned: The divorce agreement should be clear about how the parents intend to claim the children as dependents. If the intent is for the custodial parent to release for all future years, the noncustodial parent will prefer to have a signed Form 8332 that says "all future years" as was the situation in the CCA (alternatively, the specific years of the release can be listed). The custodial parent may prefer instead to execute a form each year. The CCA reminds us though, that even "all future years" is not permanent because Regs. Sec. 1.152-4(e)(3) and Form 8332 provide a procedure for the custodial parent to revoke the release for future years.
According to the instructions for Part III of Form 8332 for revocation of a release, the custodial parent must provide a copy to the noncustodial parent and maintain proof of delivery or of the "reasonable efforts" to deliver it. In addition, the custodial parent must attach a copy to the return for every year an exemption is claimed due to the revocation of the earlier release.
Presumption for mother?
In Rivas, T.C. Memo. 2016-158, both divorced parents claimed their four children as dependents. The case involved the father who also claimed head-of-household status and had other tax issues before the court as well. The court noted that Rivas failed to carry his burden of proof for the four exemptions as he "set forth no specific facts" and provided no documentation to show how many days the children resided with him or the support he provided. He also did not attach a Form 8332 to his return. Thus, the court denied the dependency exemptions and head-of-household filing status.
Observations: Rivas does not provide enough facts to know whether the IRS also sought proof from the mother to determine if she was the custodial parent. IRM Section 184.108.40.206.9 on verifying Form 8332 states that CCA 200646014 may be considered to determine which parent is entitled to the dependency exemption. This CCA states that, if both parents claim exemptions and one attaches Form 8332, "the Service will need to address the issue by considering all relevant evidence of the custodial parent's waiver of the exemption and may consider the form in evaluating the parent's claim during examination." In Rivas, there was no Form 8332, so perhaps the IRS did start with the father to determine if he could prove he was the custodial parent.
Age and additional tax forms to consider
Conti, T.C. Memo. 2016-162, involved whether the divorced father was entitled to dependency exemptions and head-of-household status for 2012 for his two children ages 19 and 21. The mother also claimed the children as dependents for 2012. As the children were minors when the parents divorced, the divorce decree gave the parents 50-50 custody, and the father testified that the children alternated living with him and his ex-wife. The father claimed that the divorce decree allowed him to claim the children as dependents until age 18. No Form 8332 was attached to the 2012 return.
For either child to be the father's "qualifying child," they would have to reside with him for over half of the year. The father was unable to describe the children's living arrangements for 2012 and did not call the children to testify. The IRS noted that the daughter's high school transcript and Form 1098-T, Tuition Statement, as well as the son's Forms 1098-T and W-2, Wage and Tax Statement, had a mix of the husband's address and a different address. Unable to determine that the children were "qualifying children," the court also considered whether they were "qualifying relatives." The son did not meet this definition as his income exceeded the exemption amount. The father was unable to prove he provided over half of the support of his daughter. Thus, he was denied the exemptions, as well as head-of-household filing status.
The court also noted that because the children were over 18, they were considered emancipated under state law. Thus, neither parent had custody of the children, making Sec. 152(e) for divorced parents inapplicable to determine who could claim the children. Instead, the general rule of Sec. 152(a), which looks at who provided over half of the person's support, applied to determine whether the children were dependents.
Lessons learned: A taxpayer needs proof of "qualifying child" or "qualifying relative" status of individuals to claim them as dependents unless a valid Form 8332 is filed. If either status depends on where the person lives, the IRS can verify this by other tax forms filed, such as Forms W-2. If a child is emancipated (generally age 18 or older), Sec. 152(e) does not apply, and a Form 8332 won't enable the custodial parent to release the exemption (the parent will have to prove that the child is a "qualifying child" or "qualifying relative").
Regs. Sec. 1.152-4, addressing the release of dependency exemptions (and its revocation), allows for use of a written declaration other than Form 8332 as long as it conforms "to the substance of the form." This can be risky as something might be omitted or unclear. The parties should use Form 8332 to be sure nothing is overlooked and to ensure that it is properly recognized by the IRS.
Regs. Sec. 1.152-4 also explains how to determine who is the custodial parent (the one "with whom the child resides for the greater number of nights during the calendar year").
The dependency rules for divorced parents are somewhat complex, and problems can result as evidenced by the rulings summarized above. The outcome usually affects not only the exemption, but also the child credit and other child-related provisions. Also, parents might not be getting sufficient (if any) tax advice from their divorce attorneys and should be reminded to discuss the arrangements with their tax adviser to be sure they understand not only the dependency exemption but other arrangements such as alimony, child support, and the basis of transferred assets.
Tax reform efforts to simplify the tax law might result in a change to rules relevant to divorced taxpayers such as Sec. 152(e). H.R. 1 (113d Congress), the Tax Reform Act of 2014, does not change the definition of dependent but does repeal the income and deduction rules for alimony. If that change becomes part of a reformed income tax system, it is possible that there could be complete "divorce" from the system of tax rules addressing divorced couples. In the meantime, expect a few Sec. 152(e)/Form 8332 court cases each year (as well as ones dealing with alimony).
Annette Nellen, Esq., CPA, CGMA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is a member of the AICPA Tax Executive Committee (vice chair) and Tax Reform Task Force. She has several reports on tax policy and reform and maintains the 21st Century Taxation blog.