Written by: Darin C. James, Esq.
It’s not often that a taxpayer can disregard a court order, but a recent audit showed one of those rare instances. The IRS audited our members on the issue of the four dependents claimed on their tax return. Our members had claimed their divorced daughter and her three children, who had lived with them for the entire year.
We sent the IRS documents proving the relationship and residence of the dependents, along with the expenses our members paid to support the extended family. Surprisingly, the examiner disallowed all four of the dependents. The explanation in the examiner’s report said that another taxpayer had claimed the same dependents. The examiner also asked for a complete copy of the daughter’s divorce order. Our members then told me that their daughter’s ex-husband must have claimed his two children. We had a copy of the court order that granted the daughter’s divorce, but not the written agreement that accompanied it.
I wrote to the examiner arguing that the children could only be claimed by the parent or grandparents with whom they lived the majority of the year, unless the custodial parent had signed a release. Our members said their daughter had not signed a release to allow the noncustodial father to claim his children as dependents. The daughter had no income and did not file a tax return. Therefore, the “tie-breaker rules” would allow the grandparents to claim the children, because the mother did not claim them, and the grandparents’ income was higher than the mother’s.
The examiner was not persuaded, and still disallowed all of the dependents. After our members received a Notice of Deficiency, we filed a petition in the U.S. Tax Court. I later discussed the case with an Appeals Officer, who offered to allow two of the dependent exemptions for the daughter and third grandchild (who was not from the daughter’s marriage). The Appeals Officer said that since the daughter’s complete divorce order was not provided, she assumed that it allowed the father to claim his two children.
Our members obtained a copy of their daughter’s entire divorce order and sent it to us. The order incorporated this written agreement between the parents: “(Father) shall be entitled to claim both minor children on his state and federal income tax returns every calendar year. If (Mother) qualifies for an exemption due to her income increasing, the parties agree to each claim one….” The agreement was signed by both parents and approved by the judge.
We sent the divorce order to the Appeals Officer. I argued that the order should not control the case because the daughter did not sign IRS Form 8332 releasing the exemptions for the children. The Appeals Officer disagreed. She said that when both parents have signed an unconditional stipulation, they consider the stipulation to be the equivalent of the required declaration in the form. She asked me to send her whatever legal authority we had to support the taxpayers’ position.
Between divorced parents, the general rule is that a child can be claimed as a dependent by the parent with whom the child lived the longest during the year. Internal Revenue Code §152(e) creates an exception to this rule by permitting a noncustodial parent to claim the dependency exemption if certain requirements are met. However, this section only applies “if a child receives over one-half of the child’s support during the calendar year from the child’s parents.” Our members had a report showing that the children’s father had paid only a very small amount of child support that year. The children’s mother had no income, so the grandparents provided most of the support.
In George v. Commissioner , the Tax Court held “If a third party (not the child or her parents) provides most of a child’s support, then – notwithstanding a purported release by the custodial parent under section 152(e) – a noncustodial parent could not claim her as a dependent.” In another recent case, Shenk v. Commissioner , the Tax Court held that even though a noncustodial parent may be entitled to a disputed dependency exemption as far as a state court is concerned, “ultimately it is the Internal Revenue Code and not State court orders that determine one’s eligibility to claim a deduction for Federal income tax purposes.”
I wrote to the Appeals Officer again, citing the case law and applicable sections of the code. The IRS finally agreed that that the divorce order did not control, because the order conflicted with the Internal Revenue Code. Our members were allowed all of the dependents claimed, and were very happy to owe no additional tax.
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 George v. Commissioner, 139 T.C. 19, CCH Dec.59,291 (2012)
 Shenk v. Commissioner, 140 T.C. 10, CCH Dec.59,528 (2013)