This is the key issue: Absent an express agreement of the parties, the dependency exemptions and the accompanying earned income credit and child care credit for minor children of divorced and separated families, belong to the custodial parent, not the non-custodial parent.
Prior to January 1, 1985, the Internal Revenue Code (IRC), as regards a divorced and/or separated parent who provided more than one-half of the child's total support during the year, the "custodial parent" had the right to claim the dependent child tax exemption. At that time, there were two exceptions under the tax code at that time that, if applicable, would permit the noncustodial parent to claim the exemption. Specifically, 26 USC § 152(e)(2) allowed the noncustodial parent to claim the exemption if:
- "a written agreement between the parents * * * provides that the parent not having custody shall be entitled to any deduction allowable under section 151 for such child," OR
- "the decree of divorce or of separate maintenance * * * provides that the parent not having custody shall be entitled to any deduction allowable under section 151 for such child."
Major revisions and amendments to the federal income tax code were enacted by Congress in the 1984 Tax Reform Act, (the "Deficit Reduction Act of 1984") (Pub L 98-369, 98 Stat 494). Relevant to this discussion, there was a significant change in the wording of 26 USC § 152(e)(2), applicable for tax years commencing after December 31, 1984. As revised, the text of 26 USC § 152(e) deleted and repealed the prior language that had expressly allowed a noncustodial parent to claim the dependency exemption “if the decree of divorce or of separate maintenance * * * [so] provides.”
As a result of the 1984 tax code revision, the previously-existing exception that effectively allowed a state court judge through a divorce decree to award to a noncustodial parent the right to claim the dependent child tax exemption --- despite objection by the custodial parent and without the custodial parent's voluntary consent --- was simply written-out of the federal income tax code for tax years commencing after 1984. Consequently, since 1985, there is only one statutory exception to the custodial parent's right to claim the exemption, that exception being the custodial parent's voluntary written agreement to not claim the exemption and to release it to the noncustodial parent. [Emphasis added.]
Michigan's case law on the issue, reviewed below, shows that if the parties treat the exemption as part of their property settlement agreement, then it is non-modifiable, absent any of the few exceptions to modification. It the parties treat the exemption as part of the child support, however, upon proof of changed circumstances, the right to use the exemption will be modifiable. Parents from states other than Michigan may use the discussion below as a guideline to allocation of the dependency tax exemptions.
IRS REGULATIONS CONTROLLING ALLOCATION OF TAX EXEMPTIONS:
To be entitled to the exemption, a taxpayer must be the custodial parent or the custodial parent must purposefully, intentionally, and in writing, waive the right to the exemption in favor of the non-custodial parent. The exemption applies to a "qualifying child" of the taxpayer.
WHO IS A "QUALIFYING CHILD?"
In summary terms, the rules for divorced parents are as follows: A child is treated as a “qualifying child” of a taxpayer, allowing that taxpayer to claim the exemption for the child, only if all four of the following statements are true:
- The parents are divorced or separated;
- The child received over half of his or her support for the year from the parents;
- The child is in the custody of one or both parents for more than one half of the year. [If this threshold is met, the divorced parent with whom the child spends more than one half of the nights in the year is entitled to claim the exemption].
- The custodial parent signs a written declaration [IRS Form 8332] stating that he or she will not claim the child as a dependent for the year. This IRS regulation means that the custodial parent must actually agree (be contractually bound) to concede the exemption to the non-custodial parent. Download IRS Form 8332
See IRS Publication 504, at page 9 for the definition of "qualifying child." Download IRS Pub 504 Note: This is the 2011 publication; at this writing, the 2012 publication has not yet been released. To find more current publications, go to http://www.irs.gov/ and search the publication list.
IRS Publication 504 defines “custodial parent” and “noncustodial parent” as follows: "The custodial parent is the parent with whom the child lived for the greater number of nights during the year. The other parent is the noncustodial parent.”
If the parents divorced or separated during the year and the child lived with both parents before the separation, the custodial parent is the one with whom the child lived for the greater number of nights during the rest of the year. A child is treated as living with a parent for a night if the child sleeps:
• At that parent’s home, whether or not the parent is present, or
• In the company of the parent, when the child does not sleep at a parent’s home (for example, the parent and child are on vacation together. See IRS Publication 504, at page 9.
In Michigan, child support calculations are calculated upon a formula that takes into consideration the number of overnights the child(ren) spend with each parent and also each parent's income (whether actual or imputed). To facilitate identification of whether the allocation of the tax exemption is related to child support or property distribution, and the parent who is the “custodial parent” for IRS purposes, SCAO has developed new FOC 10, FOC 10a and FOC 10b forms. You can see and download the new SCAO FOC 10 Uniform Child Support Orders here: See especially Paragraph 3 of the forms.
“The payer is ordered to pay a monthly child support obligation as follows:
Payer ____________ Payee ____________ Support effective date ________
Children's names, birth dates, and annual overnights with payer: ________
Some of the Michigan cases have challenged a trial court's modification of the IRS exemption. To be non-modifiable, the exemption must be part of the property settlement. See that body of law dealing with non-modifiable property settlements and finality of judgments. As always, upon proof of changed circumstances, an allocation that is related to child support may be modified under the appropriate set of facts. See, e.g., the Clarke case discussed below.
In Michigan, the case law specifically analyzes whether the allocation is part of the property settlement or part of the child support provisions of the judgment. Where the appellate court has been unable to determine the basis of the award, then the cases have been remanded for a determination of that issue.
ANALYZING A CASE:
Let's take a hypothetical case, using the following presumptions:
- Mother is the primary custodial parent and the children spend 223 overnights per year with her.
- Father is the non-custodial parent and the children spend 142 overnights per year with him.
- Mother has not agreed to concede a dependency exemption to Father; in fact, she has specifically objected to doing so.
- The record is clear that the dependency exemption is related to child support. In fact, the new SCAO Uniform Support Orders make it clear that Mother is the "custodial parent"
- The record is clear that the dependency exemption is not related to property distribution. It is not contained within the property distribution section of any judgment, nor is it described as part of the property distribution.
Conclusion: The parties have clearly not negotiated any enforceable property settlement agreement that allocates the exemptions to the non-custodial parent. The Mother has clearly not become contractually bound to allocate or to release the dependency deduction to Defendant Father. Mother is entitled to the exemption.
IRS REQUIREMENTS FOR NON-CUSTODIAL PARENT'S USE OF EXEMPTIONS:
The only way the non-custodial parent can claim a dependency exemption is by agreement of the custodial parent who must then sign an unconditional written declaration which must be attached to the tax return of the non-custodial parent. The IRS has established Form 8332 for this purpose. These rules are established in IRC Section 152 and Treasury Regulations Section 1.152-4. Note that a custodial parent may release the exemption for a certain year or for all years. Note also at the bottom of Form 8332, unless the release of the exemption is part of the property settlement and is, thus, non-modifiable, the custodial parent may revoke the release in subsequent years.
THE MICHIGAN CASES:
In Young v. Young, 182 Mich. App. 643 (1990), (cited by the Court of Appeals ["COA"] in Fear v Rogers, infra), the COA decided the case on other grounds—the fact that the judgment of divorce allocating the exemptions was a divorce judgment that was a "qualified pre-1985 instrument" under Sec. 152(e) of the Internal Revenue Code [26 U.S.C. Sec. 152(e) ] entered prior to January 1, 1985.” As a result, “[t]he tax provision at issue requires a pre-1985 divorce judgment to have specifically awarded the dependency exemptions and recognizes only subsequent modifications which are consistent with the act.”
TAX EXEMPTIONS: RELATED TO PROPERTY AWARD OR CHILD SUPPORT?
CLASSIFICATION ONE—PROPERTY SETTLEMENT AWARD
The dependency exemption treated as part of the property settlement is non-modifiable (absent conditions that may result in modification): This, of course, presupposes that the parties contractually agree to this allocation, or, in one Michigan case, have become contractually bound to the allocation by their agreement to submit all issues to binding arbitration. The importance of this strategy for the allocation is this: property settlement agreements are non-modifiable. A example of why this might work for some couples is:
a) Parent A (usually the non-custodial father) has a far higher annual gross income and the dependency exemptions are more meaningful to him, while
b) Parent B (usually the custodial mother) does not work because the cost of childcare would be nearly equal to her earning capacity. As a result, Mother would pay no income taxes anyway, and the dependency exemptions are not meaningful for her when Father is willing to give her something meaningful (e.g., more property, a higher distribution of cash, etc.) in exchange for the exemptions.
The first case in this category was Fear v Rogers, 207 Mich App 642, 646-647 (1994). Download Fear v Rogers The Fear panel decided, citing Young, supra, that case law allows the parties to agree to allocate the federal income tax exemptions in a manner that does not conform to the U.S. Tax Code as part of a property settlement.
The Fear panel acknowledged that ordinarily, the dependency exemption would be considered part of the child support provisions and, would thus be modifiable. Plaintiff Father argued in Fear that the allocation of the exemptions was part of the parties’ property settlement agreement. However, the Fear panel held as follows:
"Plaintiff urges that it was treated as a property issue. However, we cannot divine that conclusion from the judgment of divorce. The allocation of the federal income tax dependency exemption was handled separately in the judgment of divorce from both the child support provisions and the property settlement provisions. Thus, we cannot say from the record before us whether the parties had chosen to treat it as a property issue or a child support issue. Accordingly, the trial court must determine on remand whether the income tax dependency exemption is to be treated as part of the property settlement, and thus subject to the restrictions on modifications of property settlements, or as part of the child support arrangements, and therefore subject to the much more liberal modification rules that govern child support awards.
"For the above reasons, we conclude that the trial court erred in entering its order modifying the judgment of divorce. The order did not reflect an enforceable agreement reached by the parties and, therefore, it was necessary for the trial court to hold the appropriate hearing before entering the order modifying the judgment of divorce. Additionally, the trial court must determine the nature of the allocation of the federal income tax dependency exemption in the judgment of divorce before determining whether it can modify the judgment to award that exemption to defendant. Fear v Rogers, supra, emphasis added.
The second case in which the Court of Appeals had to consider the dependency exemption as part of the property settlement was Frain v Frain, 213 Mich.App. 509 (1995). Download Frain v Frain There, the parties agreed to binding arbitration. In other words, the parties agreed to be contractually bound by the mediator’s decision, which could only be set aside if the mediator is shown to have exceeded his authority.
“This leaves plaintiff's remaining objection, that the mediator erred in awarding two of the tax exemptions for the minor children to defendant. Arguably the mediator would have exceeded his authority if state courts lack the power to award federal income tax exemptions as plaintiff argues. However, plaintiff is incorrect that state courts lack that power. Rather, as we observed in Fear v. Rogers, 207 Mich.App. 642, 645, 526 N.W.2d 197 (1994), it is within the authority of state courts in domestic relations matters to award the federal income tax dependency exemptions for the minor children. Thus, it was within the mediator's power to award the income tax exemptions, and plaintiff's argument is reduced to whether the mediator should have awarded two of those exemptions to defendant. But such issues are beyond the scope of judicial review of the mediator's decision." Frain, supra, 213 Mich.App. 512-513.
CLASSIFICATION TWO: THE EXEMPTIONS AS RELATED TO CHILD SUPPORT
The holding in Fear and all of the later cases show clearly that the dispositive ruling is NOT that “the trial court has the authority to allocate the dependency exemptions” any old way that it decides, but rather is this: the trial court has the authority to accept the parties’ contractual agreement to allocate the exemption as part of their property settlement agreement. If they do so in a clear and unambiguous manner, then a subsequent court may not modify that property distribution.
If, however, the allocation of the exemptions is part of the child support provisions, it must be dealt with according to IRS regulations and the custodial parent with the greater number of overnights will be entitled to the exemptions. If there is a change in circumstances, the exemptions may also be modified later.
In more recent cases, the Court of Appeals has remanded cases to the trial court (as it did in Fear v Rogers, supra) where the record was not clear whether the allocation of tax exemptions was part of the property distribution or was included in the child support part of the judgment.
In Clarke, 290 Mich App 172 (2012): [released for publication on June 26, 2012, Michigan COA Docket No. 303580] Download Clarke_v_Clarke In Clarke, the Court of Appeals acknowledged the holding in Young and Fear, supra at 646-647 [the trial court has the authority to modify an order regarding the federal dependency tax exemption where it is considered part of the child support award].
The Clarke Court noted as follows:
"According to the divorce judgment, the parties agreed to alternate the yearly federal dependency tax exemption for Edwin:
"In the odd numbered years Edwin will spend one day more than half time with Defendant, and Defendant will be entitled to claim head of household filing status and to claim Edwin as a dependent. In the even numbered years Edwin will spend one day more than half time with Plaintiff, and Plaintiff will be entitled to claim head of household filing status and to claim Edwin as a dependent. Each party will execute any IRS documents necessary to effectuate this provision." [Emphasis added]
The Court of Appeals could readily ascertain from the record that “since January 2010, [the child] has been exclusively residing with defendant.” Thus, there was a change in circumstances sufficient to modify the exemption allocation. As a result, the Clarke panel held that the trial court’s decision to modify the order and award the federal dependency tax exemption for Edwin to the defendant was appropriate.
PRACTICE TIP: The Clarke case raises another interesting issue with respect to the exemption issue. Note that the Clarkes were very careful to enunciate that the child would spend "one day more than half time" with Father in even-numbered years and "one day more than half time" with Mother in odd-numbered years. More often than not, I see Friend of the Court recommendations that say that the child will spend "182.5 days per year with Mother and 182.5 days per year with Father." The tax exemption is given to Mother in even-numbered years and to Father in odd-numbered years (for example). Now what about Leap Year? That is an even-numbered year, so you would think that Mother is entitled to the exemption. But that isn't necessarily so. The child lived with Mother and Father an equal amount of time (183 overnights). There is a "tie-breaker rule" that applies. Under this tie-breaker rule, the parent who has the highest adjusted gross income is entitled to the exemption. See IRS Pub 501 at page 14. Download IRS Pub 501 Highlighted
CAVEAT: Do remember, if you access this blog post after its publication date, that the statements above relate to the current state of the tax code. Who knows what Congress might do in 2013 or afterwards!