Divorce – particularly divorces involving children – typically complicates tax issues. Individual states determine their own divorce and custody laws, while the Internal Revenue Code, which governs taxes, is federal legislation. However, federal law supersedes state law, and when it comes to tax breaks for parents, the IRC spells everything out in great detail. It also imposes a lot of qualifying rules.
Different states often use different terms for the same custody concepts, and the phrase "shared custody" is a prime example. The term can refer to joint physical custody, joint legal custody, or parents sharing both physical and legal custody. For tax purposes, physical custody is the arrangement that particularly matters, because the tax code bases several credits and deductions on where a child lives during the tax year. Shared or joint physical custody rarely works out to an exact 50/50 division of time between parents, however. Even if your divorce decree or custody order states that you have shared physical custody, this might not impress the Internal Revenue Service or earn you a tax break.
Tax credits and the dependent deduction usually go hand-in-hand; you can't claim the credit if you don't first have the deduction. The IRS gives the dependent deduction to the parent with whom the child lives most during the tax year. Unless your shared custody arrangement involves your child living with you 182 days a year, with your ex 182 days a year, and sharing the last day of the year with both of you, one of you is the custodial parent according to IRS rules, because one of you has your child a little more than the other. That parent is the custodial parent for IRS purposes, and she gets the deduction. If your shared custody arrangement actually is an exact 50/50 split of parenting time, the IRS gives the deduction to the parent with the highest adjusted gross income. Otherwise, if you have your child 45 percent of the year, and your ex has her 55 percent of the year, your ex is the custodial parent, regardless of what your divorce decree or custody order says.
Waiving the Deduction
If you lose the dependent deduction because your ex has slightly more time with your child or because her AGI is higher than yours, she can voluntarily waive the right to claim it and give it to you instead. However, this also involves some qualifying rules. You, your ex or both of you must pay for more than half your child's living expenses for the year, and your custody arrangement must be memorialized in a court order or divorce decree. If this is the case, your ex can sign IRS Form 8332, giving you the right to claim the dependent deduction for your child. You must attach the form to your tax return when you file, claiming the deduction.
Child Care Tax Credit
You must claim your child as a dependent to claim the child care tax credit, but you can't use Form 8332 to qualify you. Your ex can't waive her right to the credit if your child actually lived with her for at least half the tax year. The child care tax credit only applies to children younger than 13, and it only covers child care costs you incur so you can work or look for work. You must have some earned income – passive unearned income from investments or retirement benefits doesn’t count. The credit is limited to a percentage of your child care costs of up to $3,000 for one child or $6,000 for two or more children, and the percentage decreases as your income rises. If your AGI is more than $43,000 a year, you're only eligible for 20 percent. The largest credit you could possibly claim would be $600 if you have one qualifying child, and double that if you have two or more.