New Rules for Qualifying Children

The Working Families Tax Relief Act of 2004 includes new rules for determining who can claim tax benefits for qualifying children, including the dependent exemption and the child credit.

The Working Families Tax Relief Act of 2004 is mostly about preventing various tax benefits from expiring (click here for details), but it includes significant new rules defining who can claim tax benefits for qualifying children. The idea is to make the rules simpler and more rational for five common tax benefits:

• personal exemptions for dependent children
• the child credit
• the earned income credit
• the dependent care credit
• head of household filing status

We aren't going to provide full details here because that would require quite a few pages of explanation. Instead, we'll cover the highlights, with special attention to situations where there may be a change as to which taxpayer can claim a child as a dependent.

Residency Trumps Support

If we had to summarize the major change in three words, we would say that under the new law, residency trumps support. Under the old law, which remains in effect through 2004, you get to claim a child as your dependent if you provide more than half the child's support (and meet other requirements). Under the new law, which takes effect in 2005, you get to claim the child as your dependent if the child's principal place of abode is the same as yours for more than half the year, even if someone else provides more than half the child's support.

Example: A child lives with an unemployed parent, and a grandparent provides most of the child's support. Under the old law, the grandparent would claim the dependency deduction. Under the new law, if the child otherwise meets the definition of a qualifying child, the dependency deduction would go to the parent with whom the child lives.

Support is still relevant in one important way: if the child provides more than half his or her own support, the child is not a qualifying child.

Divorce or Separation

Both the old law and the new law will recognize waivers that permit one parent to claim a child as a dependent. If you are currently in a situation where the right to claim the child as a dependent is based on a waiver from the child's other parent, the right to claim the exemption will not change.

Tie-Breaking Rules

There are times when more than one taxpayer could be entitled to treat a child as a qualifying child. For example, the child might live with both parents for seven months, and then live with only one of them following a separation. For another example, a child might live with a parent and a grandparent. Under the old law, the exemption (and child credit, if available) would go to the person who provided more than half the child's support. Under the new law, the exemption may be claimed by any taxpayer who qualifies, provided that no one else claims the exemption. If more than one taxpayer claims the exemption, it will go to one who "wins" according to tie-breaking rules:

• Between a parent and someone who is not a parent, the parent "wins."
• Between two parents, the one with whom the child resides the longest "wins."
• If the child resides the same amount of time with both parents, the one with higher adjusted gross income "wins."
• Between two individuals who are not parents, the one with the higher adjusted gross income "wins."

These rules can produce unfairness, particularly if the person with a smaller amount of income (lower adjusted gross income) is more generous in providing support to the child. Overall the rules should make it easier to determine who is entitled to claim the child as a dependent in most cases, and will usually provide a fair result.

Other Rules

Other rules mostly remain the same. For example, the rules for claiming someone other than a qualifying child as a dependent are not changed. Furthermore, there is no change in the "magic ages." The child credit still requires the child to be under 17, and the qualifying child definition in general applies only if the child is under 19 (or in the case of a full-time student, 24). Likewise, the dependent care credit continues to apply up to age 13 for children who are not disabled.

Effective Date

As noted earlier, the old rules apply through 2004. That means you'll use the old rules when you file your 2004 tax return in 2005. The new rules apply to tax years 2005 and later.