It is important that parents be aware of the tax treatment of child support in the context of divorce or separation as well as issues involving child custody. The manner in which child maintenance is characterized in the settlement agreement can have far-reaching consequences tax-wise.
Child support is not tax deductible for the payor nor is it deemed taxable income for the recipient parent. Therefore, it is not reported as income on the tax return by the payor, and unlike alimony payments, it cannot be claimed as a deduction by the paying parent. The law treats child maintenance payments as family expenses. It is important that child support be paid separately from other forms of payment and that it be clearly designated as "child support" in the separation or dissolution agreement. If the agreement fails to specify a designated portion of every payment as constituting child support or combines the payments as 'alimony', then none of the payments will be deemed child support for purposes of taxation. This will be disavantageous for the recipient spouse since he or she will be taxed on the payment as if it were alimony.
Direct expenses that a payor spouse pays pursuant to a child support order can also not be deducted as business expenses.
As a general rule, to claim a children as a tax exemption, a parent must supply at least half of the child support during the year in question. The IRS will grant a custodial parent who has lived apart from the non-custodial parent for the last six months or who has a separation agreement, child support agreement or divorce decree the right to count his or her children as a tax exemption.
By contrast, the non-custodial parent may be allowed to claim his child as an exemption if one of the two following scenarios occurs:
1) The custodial spouse signs IRS Form 8332 surrendering his or her right to claim the exemption for the dependent, and the non-custodial spouse includes the declaration in his or her tax return; or
2) There is a waiver of the dependent exemption by the custodial spouse in the separation agreement or divorce decree.
To be eligible to file as head of household, a parent must have contributed more than 50% the cost of maintaining a home for the tax year in question. If both parents contributed the same amount, neither would be eligible for this filing status.
To claim the education tax credit, which provides a full subtraction from the federal income tax for a child's post-secondary educational expenses, a parent must have the right to claim a child as a dependent. Non-custodial spouses who are able to claim a child as a dependent on their tax return may be eligible for other education tax credits known as the lifetime learning credit or the hope credit.
Qualifying low-to-moderate income custodial parents of one or more children may avail themselves of the earned income tax credit (EITC), which is refundable and ranges from $3 to $4,140. Where the parents are divorced, the one with whom the child resided for more than six months of the year is eligible for the EITC. If the child resided with both parents for an equivalent period of time, the IRS will offer the credit to the spouse with the highest adjusted gross income.
The child care tax credit is calculated as a percentage of the permissible expenses on the basis of the parent's income. For calculation of this credit, the maximum amount of child care costs are $2,400 per child or $4,800 for two or more qualifying children. A non-custodial spouse cannot claim this credit even if she is entitled to the dependency exemption and succeeds in claiming the qualifying child as a dependent.
To be eligible for the child tax credit, which allows a parent to lower his or her taxable income by up to $1,000 per child under the age of seventeen, the child must 1) be a resident alien or a U.S. citizen, 2) be claimed as his or her dependent, 3) be below the age of 17 at the end of the year, and 4) be his or her sibling, eligible foster child or stepchild, stepsibling or descendant, grandchild, adopted child, daughter, or son. A parent can claim the child tax credit by filing form 1040 or 1040A. The child tax credit is restricted if a parent's modified adjusted income exceeds a specific amount. It is also limited by the income tax sum that an individual owes. Only the parent claiming the dependency exemption may claim the child tax credit.