In general, there are four different types of child tax credits that divorcing parents should understand before resolving which parent will claim the dependency exemption and/or how joint custody should be addressed in an agreement.
Taxpayers may be able to claim a tax credit of $1,000 for each qualifying child. In this case, a qualifying child is one that is claimed as a dependent, was age 16 or younger at the end of the year, and is a child that is the taxpayer's own (or that of their brother or sister and is cared by them as their own child). The child tax credit is phased out if adjusted gross income is above $75,000 for Head of Household and Single filers. Note this credit is refundable.
Child and Dependent Care Credit (Claimed by Custodial Parent)
If a custodial parent pays for care for a qualifying dependent that was age 12 or younger when the care was provided or for other dependents that are not able to care for themselves, then they may be eligible for the child and dependent care credit. To qualify, one must satisfy all of the IRS tests summarized below:
This credit can be up to 35% of up to $3,000 of expenses associated with the care of one individual or up to 35% of $6,000 for two or more individuals. If the taxpayer's adjusted gross income is more than $15,000, they will receive less than the full credit (i.e. the "phase out" begins). However, for taxpayers with more than $45,000 of adjusted gross income, the credit is still 20% of qualifying expenses (i.e. up to $600 for one child, $1,200 for two or more). Note this credit is not refundable.
Earned Income Credits (Claimed by Custodial Parent)
The earned income tax credit (or EIC) is a refundable credit (meaning if the credit exceeds the tax liability, the IRS will mail the taxpayer money) that is often the most valuable of all the tax credits. It can only be claimed by the custodial parent. The value can be slightly more than $3,000 if the taxpayer has one child to more than $5,500 for three or more children. To claim the credit, a taxpayer must have earned income of less than $35,000 with one qualifying child and up to $45,000 for three or more qualifying children.
There are other qualifying rules, for example, if you have more than $3,100 in investment income, then you cannot claim this tax credit. As was the situation with the Child and Dependent Care Credit, a worksheet is provided on the 1040 tax form to calculate the exact earned income credits.
Education Tax Credits
There are two tax credits that presently apply to education - the American Opportunity Tax Credit ("AOTC") and the Lifetime Learning Credit ("LLC"). In any year, a parent claiming a dependent can only take one of the credits.
The maximum AOTC is $2,500 and is subject to phase out when modified adjusted gross income is over $80,000 (or $160,000 for jointly filed returns). 40% of the credit is refundable. Note this credit is due to expire in 2011.
The LLC is 20% of the first $10,000 paid for qualifying tuition and related expenses each year. The maximum credit is currently $2,000. Expenses for graduate and undergraduate work are eligible. There is no limit on the number of years that this credit can be claimed. The amount of the credit is phased out if modified adjusted gross income is between $50,000 and $60,000 ($100,000 and $120,000 if you file a joint return).
Often it is the case that after divorce, one taxpayer can benefit from the above tax credits to a greater extent than the other. So, when negotiating a divorce settlement, learn how the various tax credits would benefit each party. Splitting dependency exemptions is a common practice, but may not take into account how the various tax credits benefit each taxpayer.
Return to top of Child Tax Credits after Divorce
Understanding child tax credits is just part of the equation when doing your taxes after divorce. What your filing status is and which parent gets to claim the children as dependents is also important. The following articles offer more information about the various tax concerns that people have during and after their divorce: