Child Tax Dependency Exemptions-You Almost Can’t Win With the IRS

by Annette Burns on January 4, 2013

We’ve seen the standard language in an Arizona Decree of Dissolution and/ or Property Settlement Agreement:

“[Husband/ Wife] is awarded the tax dependency exemption for the minor child so long as [his/her] child support obligation is current not later than December 31 for the year in which the exemption is to be claimed. [Husband/ Wife] is ordered to execute and deliver IRS Form 8332 releasing the exemption to [Husband/ Wife]. ”

Unfortunately, things don’t always work out the way the Decree anticipates. Let’s say that Husband is awarded the dependency exemption, provided that his child support is current. That language, by the way, comes directly from Arizona’s Child Support Guidelines, Section 27, which states:

In any case in which the current child support obligation is at least $1,200 per year, there should be an allocation of the federal tax exemptions applicable to the minor children which as closely as possible approximates the percentages of child support being provided by each of the parents. If it is determined that a party who is otherwise entitled to the dependency exemption based upon the above percentages will not derive a tax benefit from claiming the dependency exemption, the exemption should be allocated to the other party. The allocation of the exemptions shall be conditioned upon payment by December 31 of the total court-ordered monthly child support obligation for the current calendar year and any court-ordered arrearage payments due during that calendar year for which the exemption is to be claimed. If these conditions have been met, the custodial parent shall execute the necessary Internal Revenue Service forms to transfer the exemptions. If the noncustodial parent has paid the current child support, but has not paid the court-ordered arrearage payments, the noncustodial parent shall not be entitled to claim the exemption. (Emphasis added)

EXAMPLE: Noncustodial parent’s percentage of gross income is approximately 67% and custodial parent’s percentage is approximately 33%. All payments are current. If there are three children, the noncustodial parent would be entitled to claim two and the custodial parent would claim one. If there is only one child, the noncustodial parent would be entitled to claim the child two out of every three years, and the custodial parent would claim the child one out of every three years.

For purposes of this section only, a noncustodial parent shall be credited as having paid child support that has been deducted on or before December 31 pursuant to an order of assignment if the amount has been received by the court or clearinghouse by January 15 of the following year.

Note that the Guidelines don’t mention IRS form 8332 in any way.

You being the intelligent attorney that you are, you make sure the requirement of a signed Form 8332 is in your final documentation. Then your client calls you and states that the ex-spouse never executed the Form 8332 for the required year, even though his child support was clearly current, and even though the Decree requires her to sign. What do you tell the client?

Clients are often told (either by attorneys or by their tax preparer) to attach the copy of the Decree that awards them the exemption. Does that work? Not according to tax court decisions. In Hanson v. Commissioner, David Hanson did attach the Decree that awarded him the exemption. But the award was not “unconditional”. Per the child support Guidelines’ wording as stated above, the award of the exemption was conditional upon current child support. As the IRS is in no position to determine if child support is current (and has no interest in getting involved in that issue), the Decree language did Mr. Hansen no good. His only recourse was to return to State Court and ask that court to enforce its order, presumably including monetary sanctions for the loss of the exemption, against his ex-spouse.

Even after chasing an ex-spouse down in State Court to obtain a signed Form 8332, it may be too late. In Browning v. Commissioner, Mr. Browning could not get the 2007 Form signed by his ex-spouse until sometime in June 2012. The ex-Ms. Browning had in fact claimed the exemption herself on her 2007 return, even though it was awarded to Mr. Browning. By the time she finally signed the Form 8332, statutes of limitation on the 2007 returns had elapsed, meaning that if the IRS allowed Mr. Browning to take the exemption on an amended return, the exemption would have been used twice. Mr. Browning, therefore, lost with the Tax Court.

Villagrana v. Commissioner    In this case, Wife was required to execute the appropriate form releasing the exemption to Husband, if he stayed current in child support.    The Court here affirmed the requirement that the form itself must be attached to Husband’s filed return for him to claim the exemptions.

Armstrong v. Commissioner   In this case, the tax court actually felt sorry for the child support payor, and yet didn’t offer him relief in the form of the exemptions.    Because he didn’t have the signed Form 8332, he was out of luck.

And finally, in George v. Commissioner,  the Tax Court had to get involved in the issue of child support arrears (which I’m sure it was not happy about), because the Wife was subject to an order of the lower court to sign the form, and yet she claimed that child support was not current.   She did sign, but claimed the form should be disregarded because the condition was not met.   The Tax Court was at least somewhat consistent when it ruled that because the form was signed, Husband got the exemption, presumably leaving the issue of child support arrears to be hashed out in state court.    The Tax Court punted somewhat by stating:   “If the State court did err by ordering Ms. George to do something that legally she should not have been required to do, then her remedy is not found in the U.S. Tax Court but rather in an appeal to the State appellate court.”

Credit for the compilation of these recent exemption cases goes to Peter J. Reilly of the Forbes.com blog “Passive Activities”.

IRS Publication 501 covers dependency exemption issues and requirements, including Form 8332.

The bottom line:  Before fighting about the dependency exemptions in either state or Tax Court, quantify what it’s worth to your client. In 2012, each exemption is worth $3800.  That’s not a $3800 savings to the filer; that’s a $3800 deduction.   At a 25% tax rate, one exemption is worth $950 per year to the tax filer ($3800 X 25% = $950).      As a single filer’s income exceeds $75,000 per year, the exemption starts to phase out and is worth even less.     At a 33% tax bracket, the exemption is worth nothing.     See “Value of Dependency Exemption” for more information.

 

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