Generally, Pennsylvania law provides that the parent who has primary physical custody of the child is entitled to claim the dependency exemption, and the child tax credit, on his or her income tax return. If the parents share physical custody, the parent who earns more income is entitled to claim these tax benefits. However, this is negotiable in divorce and child support actions.
The ability to claim the child on your income tax return can benefit a parent by changing the filing status from “single” or “married filing separately” to “head of household”, a more beneficial filing status under the tax code. This may decrease the amount of tax you owe. However, the dependency exemption may be a greater benefit to the non-custodial parent and, therefore, may be worth negotiating in a divorce or support action.
For example, if claiming the child as a dependent will save the non-custodial parent $5,000.00 in tax, but will only save the custodial parent $1,000.00 in tax, then the non-custodial parent should claim the child as a dependent and pay the custodial parent the $1,000.00 she would otherwise would have saved. The net savings to the non-custodial parent is $4,000.00. (And, a good lawyer could even negotiate sharing this $4,000.00 tax savings between the parties!)
A second benefit for the parent claiming the child is the Child Tax Credit. The Child Tax Credit allows you to claim $1,000.00 for each qualifying child. So, in a family with three children, the credit is worth $3,000.00. This credit also reduces the tax you owe. However, the Child Tax Credit is phased out for certain higher income tax payers. Specifically, the amount of the credit allowable is reduced by $50.00 for each $1,000.00 of modified adjusted gross income above a threshold amount. That threshold amount is $110,00.00 on a joint return, $75,000.00 for single and head of household filers, and $55,000.00 for married individuals who file separate returns. This means, for example, that a married couple filing jointly who have one qualifying child would be entitled to a credit of $950.00 if their modified adjusted gross income is more than $110,000.00, but not more than $111,000.00. They lose the credit completely if their modified adjusted gross income is more than $129,000.00.
It is important to understand how the Filing Status, Dependency Exemption and Child Tax Credit can affect your personal income tax return. It also is important to understand how they can affect the other parent’s income tax return. Your accountant and attorney should discuss these tax benefits and how they will affect your tax returns before you file your 2007 taxes, and in the foreseeable future. There are very specific financial benefits that could be negotiated in your divorce and support actions, in a way that positively affects both you and your spouse or former spouse. It always feels good to find a way to pay less taxes, even if it saves your "ex" some money too.