IRS Issues "Tie-Breaking" Rule
The IRS recently provided guidance on who can claim a qualifying child as a dependent for six different purposes. Notice 2006-86 clarifies the rules under Code Section 152(c) for two or more taxpayers claiming a child and for special rules for divorced parents.
Of the six situations below, the Notice only impacts benefits administration in one area (dependent care assistance programs [DCAPs]):
- DCAP exclusion
- Dependent care tax credit (DCTC)
- Child tax credit (CTC)
- Earned income credit (EIC)
- Head of household filing status
- Dependency deduction
A child is treated as the qualifying child of the taxpayer who is the child’s parent. However, if none of the taxpayers are the child’s parent, you look at which taxpayer has the highest adjusted gross income. The guidance also clarifies that if both taxpayers are the child’s parents and they do not file a joint return together, the child is treated as the qualifying child of the parent with whom the child resides for the longest period of time during the tax year. If the child resides with both parents for the same amount of time, the child is treated as the qualifying child of the parent with the higher adjusted gross income.
The IRS set out five separate examples on how these rules play out for the six areas where dependent status is important. The effect of this rule on DCAP administrators is simple: only the custodial parent is entitled to claim a child under the DCAP. Please note the DCAP rule is different from the rule under Code Section 105(b) that applies to divorced or separated parents participating in a health FSA.
This guidance applies retroactively to taxable years beginning after December 31, 2004, and is effective until the IRS and Treasury issue consistent regulations, which we anticipate will occur within the next 12 months.
To obtain a copy: http://www.irs.gov/pub/irs-drop/n-06-86.pdf.
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