Divorced, Never Married and Non-traditional Families and Tax Credits
by: Iowa Legal Aid
An important part of figuring income taxes is claiming dependency exemptions and credits. You can claim a dependency exemption for a "qualifying child" or a "qualifying relative." Starting in 2005, the IRS created new definitions for both of these exemptions. The rules on claiming dependents are complicated especially in families where parents are divorced, never married or when many generations on one family live together. Fortunately, free help is available for low-income taxpayers at Volunteer Income Tax Assistance (VITA) sites or Tax Counseling for the Elderly (TCE) sites in Iowa.
The definitions of qualifying child and qualifying relative impact who can claim children or other relatives as dependents - and who cannot. Each dependency exemption lowers a taxpayers taxable income by $3,500. Some very low-income taxpayers may not benefit from the dependency exemption itself. Where the taxpayer may benefit is from the refundable credit such as the Earned Income Credit. In most cases, you must be able to claim the dependency exemption in order to claim many of the child-oriented credits. There are exceptions for divorced parents, never married parents or separated parents. Non-custodial parents may be able to claim the dependency exemptions and child tax credit, while the custodial parent may be able to claim the child dependent credit and earned income credit and Head of Household filing status.
To make it easier to see what situations may come up, here are three examples. These examples involve three kinds of tax credits:
The Earned Income Credit. Information in the box on this page explains the Earned Income Credit;
The Child Tax Credit. The child tax credit is for children under age 17 who live with a taxpayer for more than half of the tax year. The Child Tax Credit can be up to $1,000 per child. If the credit exceeds the amount of tax owed, a part of the credit may be refundable and is called the additional child tax credit if the taxpayer earned more than $8,500; and
The Dependent Care Tax Credit. This tax credit helps families who qualify use their child care costs to reduce their taxable income. Depending on their income, this credit can be between 20 percent and 35 percent of the first $3,000 in child care costs for one child. For two or more children, it can apply to 20-35 percent of the first $6,000 in child care costs. For instance, a worker who earns $25,000 and spends $3,000 on her one child can get a $900 credit or 30% of the $3,000 she spent in child care. The child has to be under the age of 13 when the expenses were incurred.
Example 1: Unmarried Couple, Harry and Sally
Harry and Sally live together with Sally's daughter, Amy. Harry supports Sally and Amy and pays all the household expenses. Sally stays home with Amy and has no income. Because Harry supports both Sally and Amy, Harry can claim them each as "qualifying relatives."If Sally had income and a filing obligation, Harry would not be able to claim Amy as she would be considered Sally's qualifying child. A qualifying child can not also be a qualifying relative of someone else.
- Harry will have to file Single. He can not file Head of Household because neither Sally or Amy meets the relationship test for head of household.
- Harry can claim Sally and Amy as dependents.
- Sally had no income so she will not file a return.
Example 2: Father, Son and three grandchildren
George, lives with his son, Alan, and his grandchildren, Jack, Jill and Jason. George earns $20,000 and Alan earns $12,000. George and Alan both help pay for household expenses. George contributes more than half the cost of maintaining the home. For the 2004 tax year, Alan could claim two children when he figured his Earned Income Tax Credit and gave all the dependency exemptions for his children plus one earned income credit to his father, George.
He cannot do the same thing for years after 2004.
This year, if Alan takes the Earned Income Credit for any of his children, he will also have to take the dependency exemption for that child. The child tax credit also goes to the person claiming the exemption for the child in question.
TIP: It is best if George and Alan agree how to file. George will likely qualify as head of household so long as he uses one of the children as a dependent. Alan could file single and claim one or two dependents and one or two children for the Earned Income Credit. This family shares expenses, so they should try to file taxes to make the most of the dependency exemptions and the Earned Income Credit. If the family disagrees and both use the same dependents for the Earned Income Credit, the IRS will give the Earned Income Credit and the Dependency Exemptions to Alan. These rules are changing again for returns filed for tax year 2009.
You may see how George and Alan maximized their Earned Income Credit, Dependency Exemptions and other credits by going to the Iowa Legal Aid Website at iowalegalaid.org. Click here to take a look at two sets of sample tax returns for George and Alan.
If George claims Head of Household, 2 dependents and Alan claims single and one dependent, George will receive a refund of $7,718 and Alan will receive a refund of $4,091. Their refunds combined would be $11,809.
If George claims Head of Household, 1 dependent and Alan claims single and two dependents, George will receive a refund of $4,774 and Alan will receive a refund of $5,954. Their refunds combined would be $10,728.
Example 3: A Divorced Couple, Harold and Nancy
Harold and Nancy got divorced in 2004. Neither Harold nor Nancy has remarried. They have three children. The children lived with Nancy for all of 2008. Harold had visitation. The divorce decree tells Harold he gets to take the children as dependency exemptions. Harold will need a signed release from Nancy to be able to claim the children as dependent. A copy of the court order is not sufficient. The IRS has a form 8332 taxpayers can use.
- Harold can file Single. He can claim the dependency exemptions and the child tax credit for all three children.
- Nancy, if otherwise qualified, can take the Earned Income Tax Credit and the Child Dependent Credit. Nancy should also be able to file head of household. This is an exception to the general rule that the person with the dependency exemption gets all the credits if they meet all of the qualifications.
Each individual taxpayer's situation is different. These are meant only as examples of how taxpayers may often be better off if they discuss how to get the most out of available tax benefits. If the taxpayers don't discuss or can't agree, the IRS will assign the benefit and it may not be nearly as beneficial.
The information included in this article is not intended or written to be used and cannot be used to avoid penalties under the Internal Revenue Code.
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