HOH vs Child Tax credit

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@jjnoel12 wrote:

I understand all of this. My coparent and I are trying to decide how to have our custody order. Alternating years seems like a fairly standard way but I’m just trying to understand the benefits of each and if one generally allows a parent a larger tax return?

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OK, so you are divorced or divorcing or separating, and negotiating an agreement?

The rules on what and how to claim a dependent in that case are here, you should try and read them.

https://www.irs.gov/pub/irs-pdf/p504.pdf

https://www.irs.gov/pub/irs-pdf/p501.pdf

We start with the basic fact that the parent with custody more than half the nights of the year is the only parent who can claim head of household, earned income credit (if they are low income) and the childcare credit.  The only thing that can be transferred to the non-custodial parent is the child tax credit.  

So one thing to consider is, will you actually arrange physical custody so the child lives in one home for 183 or more days in one year, and 183 or more days in the other home the next year, or will the child pretty much be living the same number of days, and the only thing to alternate is claiming the dependent.  If the child will be living with the same parent for at least 183 nights each year, then the only thing that changes with alternating the dependent claim is the child tax credit.

For 2021, the child tax credit is $3600 up to age 6 and $3000 up to age 17, and does not depend on income.  If that credit expires, it will go back to the previous credit which was $2000 up to age 16, and required at least some income earned from working to be able to claim.  I'm sure the Democrats in Congress will try to make the new larger credit permanent, but for now it is temporary.  

In 2026, the Trump tax reform will expire, unless Congress extends it.  That would mean that in addition to the $2000 (or $3000) child tax credit, the parent who claims the child as a dependent will get a dependent exemption.  This will exempt about $5000 of their income from taxation, which translates to a $800-$1600 of additional tax savings depending on their income. 

So essentially, the parent where the child lives more than half the year will give up $2000-$4600 of their tax refund if they agree to allow the other parent to claim the child as a dependent, and the other parent will gain about that much.  The exact amount will depend on what Congress does over the next 6 years, and could change even more if Congress does even more unexpected things.  

It's also important to know that even if the custody order says that the custodial parent must give the non-custodial parent a signed form 8332 in alternating years, if the custodial parent refuses because they are in a bad mood, the IRS will not enforce the court order.  The non-custodial parent who is being "deprived" of a tax benefit, will have to go back to the family court judge to try and enforce the order, as the IRS won't get involved in the dispute.

I am not an attorney, but it seems to me that if the "transferrable" tax benefit of claiming a child as a dependent is worth on average $3000 per year, it would be more sensible for the non-custodial parent to pay less child support in alternating years and leave the tax returns alone, let the custodial parent always claim the child, and adjust the child support payments instead.  That way, the custodial parent can't "deprive" the non-custodial parent of the dependent claim by refusing to sign form 8332.  Or generally reduce child support by $1500 every year.  Just a thought.