Tuesday, July 1, 2014

Revenue Finds Taxpayer as Custodial Parent Rightfully Claimed Child for EITC Purposes Despite Releasing Child's Dependency to Non-Custodial Parent

Excerpts of Revenue's Determination follow:

Taxpayer, an Indiana resident, filed her 2011 federal and Indiana returns as head of household with two children ("Child 1" and "Child 2"). Taxpayer is divorced from the father of Child 1 and Child 2. Taxpayer took the Earned Income Tax Credit ("EITC") on the returns because she was the custodial parent of her two children ("Child 1" and "Child 2").

In reviewing Taxpayer's 2011 individual adjusted gross income tax return, the Department reduced Taxpayer's EITC because the Department believed that Taxpayer and her former spouse both claimed the EITC on the same child, Child 2, which the Department believed contravened federal and, therefore, Indiana law. Taxpayer protested that she was allowed the EITC she claimed on her federal and Indiana returns because she was the custodial parent for Child 1 and Child 2 during 2011, and she and Child 1 and Child 2 otherwise met all the EITC requirements.

Being able to claim a dependent on a federal and Indiana tax return is tied to a number of tax credits. Taxpayers can deduct an additional personal exemption for each dependent that they claim. I.R.C. § 21. Taxpayers who claim a dependent may also be eligible for other child-related tax benefits, including but not limited to, the child and dependent care tax credit (I.R.C. § 151), the child tax credit (I.R.C. § 24), certain education credits (I.R.C. § 25A), and, at issue in this protest, the earned income tax credit (I.R.C. § 32) - if certain qualifications are met.

In circumstances that involve a divorce there may be questions as to which parent may claim certain credits. Generally, it is only the custodial parent who is eligible to claim child-related federal tax benefits. I.R.C. § 152(e)(1). However, the custodial parent may waive his or her right to claim a dependent in favor of the non-custodial parent, as Taxpayer did regarding Child 2 in this case. I.R.C. § 152(e)(2). However, even after releasing the claim to a dependent, the custodial parent would still be eligible to claim the EITC since I.R.C. § 32(c)(1). The dependency credit has no relationship to the EITC. To qualify for the EITC, Taxpayer would have to be an "eligible individual" under I.R.C. § 32(c)(1) with earned income that meets certain qualifications under I.R.C. § 32(c)(2).

In this case, Taxpayer was an "eligible individual" because she had a "qualifying child" under I.R.C. § 32(c)(3). The credit and phase out percentages of the EITC are calculated based on the number of "qualifying children" of a taxpayer under federal law. I.R.C. § 32(b).

Here, Taxpayer was the custodial parent of Child 2. She released her claim to Child 2's dependency to her former spouse, the child's father, as part of a divorce agreement. After the hearing, Taxpayer provided a copy of her divorce decree as evidence. Once a custodial parent releases a claim to the dependency exemption for a child, the custodial parent may not claim this or some of the other credits for the child; however, the custodial parent may still claim the EITC.

The Department did not question that Taxpayer met all the other EITC qualification requirements. The only contention by the Department related to the fact that Child 2's dependency was released to the non-custodial parent. As stated above, even though the custodial parent released Child 2's dependency to the non-custodial parent, this release of dependency has nothing to do with the custodial parent's ability to claim Child 2 for EITC purposes. Taxpayer correctly included Child 2 in calculating her credit percentage for EITC.

Therefore, based on the above, the Department was mistaken in reducing Taxpayer's EITC. Taxpayer rightly claimed Child 2 for EITC purposes.