Three common tax issues arise with children and divorce:
1. Dependent child exemption. As a general rule, the custodial parent is entitled to claim the dependency exemption. The custodial parent is defined by the IRS as the parent whom the child lived with for the greater number of nights during the year.
Note – joint legal custody (i.e. joint decision-making) is not relevant for purposes of determining the exemption. It is physical (residential) custody that counts.
However, the custodial parent can give this exemption to the non-custodial parent by signing IRS Form 8332. It is often a point that is negotiated during the divorce process. For example, parents may alternate the claiming the child or, in the case of multiple children, one parent claims Jane and the other claims John.
2. Child care credit – also known as day care credit. Only the custodial parent can use this credit. Therefore, unlike the dependency exemption, it cannot be assigned to the noncustodial parent.
3. Child tax credit. This tax credit may be worth as much as $1,000 per qualifying child depending on one’s income. Several factors must be satisfied to claim this credit. At a minimum, the taxpayer must be able to claim the child as a dependent.