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What To Do If the IRS Challenges Your Dependency Exemptions or Child-Related Tax Credits

Authored By: Iowa Legal Aid LSC Funded
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What To Do If the IRS Challenges Your Dependency Exemptions or Child-Related Tax Credits

The first rule is don’t panic! The IRS sends out different types of notices and letters about dependency exemptions and child-related tax credits. The IRS uses computer programs to look for common mistakes made on returns. Some returns are flagged because more than one person claimed the same dependent. The IRS also selects some returns at random to review. The key is figuring out the root of the problem.

Photo of tax formsWho can be a dependent? 
Dependency exemptions are allowed for a “qualifying child” or a “qualifying relative.” The definitions of qualifying child and qualifying relative impact who can claim children or other relatives as dependents - and who cannot. Each dependency exemption lowers a taxpayer’s taxable income by a set amount. For the 2011 tax year, the amount is $3,700.

Rules for claiming dependents can be complicated. This is especially the case in families where parents are divorced or never married, or when many generations of one family live together. Special rules apply to dependents who are married. This article explains the basics but does not explain everything. There are some special rules and exceptions to the rules not discussed here. More information about these can be found in Publication 501 at www.irs.gov.

How to Find Out if a Child is a “Qualifying Child” for a Dependency Exemption

Qualifying children in general must meet every one of these six tests:

  • Test 1: Relationship The qualifying child must be a son/daughter, sister/brother, stepchild, child of taxpayer’s sibling, grandchild or adopted child as long as the child lived with taxpayer for more than six months in 2011. Foster children placed with the taxpayer more than six months of the year by an authorized government or private placement agency also qualify.
  • Test 2: Child’s Age The qualifying child must be:
    • under age 19, OR
    • under age 24 if the child is a full-time student, OR
    • a child with a total and permanent disability (of any age)
  • Test 3: Taxpayer’s Age The qualifying child must be younger than the taxpayer unless the child is totally and permanently disabled.
  • Test 4: Residence The qualifying child must have lived with the taxpayer more than half the year.
  • Test 5: Support The child must not have provided more than half his or her own support.
  • Test 6: Tie-Breaker If the child is the qualifying child of more than one person, the taxpayer must be the one who meets the tie-breaker test.

How to Find Out if a Relative is a “Qualifying Relative” for a Deduction

In general, to be a “qualifying relative” a person must meet every one of these four tests:

  • Test 1: Not a Qualifying Child The person who is the taxpayer’s qualifying relative cannot be anyone else’s qualifying child.
  • Test 2: Relationship or Residence The person must be related to the taxpayer in one of the ways listed above and be a U.S. citizen, U.S. National or live in the U.S., Canada or Mexico, or have lived with the taxpayer for the entire year.
  • Test 3: Gross Income The person must have gross income of less than $3,700 for the year. (The dollar amount may change each year.)
  • Test 4: Support The taxpayer must provide more than half the person’s total support for the year.

What is the Tie-Breaker Test?

Under the tie-breaker test, the IRS will grant the qualifying child to a taxpayer in the following order:

  1. The parents, if they file a joint return;
  2. The parent, if only one of the persons claiming the child is the child’s parent;
  3. The parent with whom the child lived the longest during the tax year, if the child’s parents do not file a joint return and are considered unmarried;
  4. The parent with the highest Adjusted Gross Income (AGI) if the child lived with each parent for the same amount of time during the tax year, and the parents do not file a joint return;
  5. A non-parent with the highest AGI, who is otherwise eligible to claim the qualifying child, if the child is not a qualifying child of either of the child’s parents;
  6. A person who is otherwise eligible to claim the qualifying child and who has a higher AGI than either of the parents when the parents have chosen not to claim the child as a qualifying child.

Internal Revenue Service
Publication 3524a

What main tax credits involve children?

The main tax redits involving children are:

  • the Earned Income Tax Credit,
  • the Child Dependent Care Credit, and
  • the Child Tax Credit.

Each credit has different rules but for all the credits the person who can claim the dependency exemption is the only one eligible to claim the credits.

The Earned Income Credit (EITC) is a “refundable” tax credit. A refundable tax credit may result in the taxpayer getting money back from the IRS. For the 2011 tax year, the EITC could be worth as much as $5,751 for a low-income working family with children. It could be worth $464 for a low-income working single person or married couple without children. In order for a child to be a qualifying child for the Earned Income Tax Credit:

  • Both the child claimed and the parents must have social security numbers that qualify the individuals for employment.
  • Taxpayers cannot file Married Filing Separately.

The Dependent Care Credit is a “non-refundable” credit. A non-refundable tax credit can reduce taxes owed but doesn’t result in the taxpayer getting any money back like can happen with the Earned Income Credit. It is available for a taxpayer who pays child care expenses for a qualifying child which allows the taxpayer to work or look for work. The child must be under the age of 13 unless the child is incapable of self-care due to physical or mental disabilities. This credit is available only to the custodial parent. (Note: The dependent care credit can also be available to a taxpayer who pays for care for another adult dependent or spouse who is incapable of self-care.)

The Child Tax Credit is available for children under age 17 who live with a taxpayer for more than half of the tax year (see Divorced, Separated or Never Married exception below). The Child Tax Credit can be up to $1,000 per child. If the credit exceeds the amount of tax owed, a part of the credit may be refundable and is called the additional child tax credit. The taxpayer needs to have more than $3,000 in earned income to qualify for this credit.

Divorced, Separated or Never Married Exception

When parents are divorced, separated, or never married, the custodial parent can sign over the dependency exemption to the non-custodial parent. The non-custodial parent may claim the dependency exemption and, if qualified, the child tax credit. The custodial parent may claim the EITC and the Child Dependent Care Credit if the parent meets all the qualifications even if the custodial parent has assigned the dependency exemption to the non-custodial parent. The easiest way to sign over the dependency exemption is to use IRS Form 8332.

What If More than One Person provides support and want to claim a deduction?

At times, a child is the qualifying child of more than one person. Sometimes more than one taxpayer will provide support for a qualifying relative. If more than one person has the same qualifying child or qualifying relative, the persons may be able to legally agree who will claim either the qualifying child or the qualifying relative. Discussing who can/should claim a dependent when both taxpayers can legally claim a dependent is good tax planning.

It is not okay to “borrow or lend” dependents to other taxpayers. Some bad tax preparers promote this practice. A neighbor or friend’s child who didn’t live with the taxpayer for the entire year and who the taxpayer didn’t support cannot be a dependent. If a preparer suggests something like this, the taxpayer should walk away and consider reporting the tax preparer to the IRS.

Situations Where the IRS Disallows or Reviews Returns Claiming a Dependent

My tax preparer says my return was rejected because someone else claimed my child. What can I do?

Custodial parents of a child can request a paper version of the return. The parent will need to sign, date and mail it in to the IRS. It may be a good idea to reach out to the other parent if there is a reason to think the other parent claimed the child and is confused about whose turn it is to claim the child or whether the non-custodial parent has the right to claim the child at all. If this is a problem that has happened more than once, the parent entitled to claim the child may wish to file as soon as he or she has all the tax information for the year. The first return filed is most likely to be successfully electronically filed and processed. The parent who files the electronic return will usually get the refund 3-4 weeks faster than when a paper return is filed.

Non-custodial parents who have a signed release (such as a form 8332 mentioned above) can mail in a signed and dated paper copy of the return with a copy of the release attached.

Non-custodial parents without a release that satisfies the IRS rules will likely be denied the dependency exemption and child tax credit. He or she will have to try to work out the situation with the custodial parent. If the other parent won’t cooperate and there is a court order in place, there may be a need to return to court to enforce the order.

The parent who claims a child without being legally entitled to the exemption or credit risks having problems with the IRS. Additional tax, interest and penalties can make such a claim a costly error and an unnecessary headache for everyone.

If you suspect a stranger has stolen your child’s information, you can contact the IRS Identity Theft unit. Ask what options there are to try to prevent the stranger from using your child’s identification. You can also file a report with your local police department. Keep a copy of any police report or forms you are asked to file. You may wish to pull your child’s credit record on a regular basis to help ensure someone is not using the child’s Social Security number for other purposes.

How should I respond to an IRS letter?

Your response depends upon the type of letter. If more than one person claims a dependent on a tax return, both individuals may receive a letter from the IRS. The IRS letter may ask the taxpayer to review the return and file an amended return if the taxpayer was not entitled to claim the dependent. With this type of letter, the IRS does not require taxpayer to do anything if the taxpayer believes he or she was correct in claiming the child.

This is not a substitue for legal adviceAnother letter a taxpayer might receive will explain that the IRS is auditing the return. When this letter is issued, the taxpayer will have to gather evidence to prove that the taxpayer is entitled to the dependency exemption and/or child related tax credits. It is very important for the taxpayer to read what types of proof the IRS wants, keep a copy of everything sent to the IRS and respond by the deadlines or ask for more time. The IRS can hold all or part of the taxpayer’s refund.

If you have tax troubles, you may be able to get help from Iowa Legal Aid’s Low-Income Taxpayer Clinic. Call 1-800-532-1275.

The information included in this article is not intended or written to be used and cannot be used to avoid penalties under the Internal Revenue Code.