Protective face mask and tax income documents for 2020. Concept for personal finances during … [+]
Divorced and never married co-parents have the chance to pick up an extra $1,100 per dependent child when they file their 2020 returns. It requires trust, cooperation and running multiple versions of their 2020 returns. It is probably not what Congress intended when it put through the package, but remember Reilly’s First Law of Tax Planning – It is what it is. Deal with it.
The opportunity comes from the peculiar way in which Economic Impact Payments (i.e. stimulus checks) interact with the Recovery Rebate Credit. To make this discussion simpler I am going to assume that nobody has adjusted gross income (AGI) over $75,000 which is when the credit starts phasing out. To follow along I recommend that you go to the Recovery Rebate Credit Worksheet on Page 58 of the Form 1040 Instructions. Despite widespread availability of various sorts of software Reilly’ Seventh Law of Tax Planning – Read the instructions – is still valid.
A Simple Example
We are going to go through the form twice and I will try to explain it well enough so you stubborn people who won’t look at the worksheet can follow along. Robin and Terry are divorced. Robin has custody of Kyle who was born in 2011. Robin and Terry each have adjusted gross income of about $60,000. Terry pays child support but never worried about getting Robin to share the exemption for Kyle. A lot of couples alternate and they are probably going to get the windfall just by keeping on keeping on. Terry pretty much figured that neither of them would die destitute and they would both be leaving everything to Kyle, so why sweat the small stuff? (BTW that attitude cuts the stress of divorce considerably).
Here we go. Let’s not worry about the boilerplate Yes/No questions. Robin, Terry and Kyle all have valid social security numbers and neither Robin nor Terry are dependents of anybody else. Robin’s form is pretty easy. Robin’s first EIP check was $1,700 – $1,200 for Robin and $500 for Kyle, so skip those lines and put a zero on line 7. The second check was $1,200 – $600 for each of them. So more skipped lines some zeros and we are done. No rebate credit for Robin. You already got yours, Robin.
If Robin continues to claim Kyle as a dependent, Terry’s worksheet will be exactly the same as Robin’s. But what if Terry claims Kyle for 2020?. Terry will have $1,700 on line 7 and $1,200 on line 11. Since Terry’s AGI (Line 11 of page 1 of 1040) is $60,000, there is some more line skipping and those amounts are moved to Lines 15 and 18 respectively where they will have the payments Terry received subtracted from them and the results added together resulting in a credit of $1,100.
But what happens to Robin who received that $1,100 up front so to speak? Nothing. The IRS made it clear back in August and there is nothing that indicates the second EIP changed anything;
Or, for example, you received $500 for your child whom you claimed on your 2018 or 2019 tax return. You do not claim the child on your 2020 tax return because the child’s other parent claims the child. You will not be required to pay back the $500 even if the child’s other parent claims $500 for the same child on his or her 2020 tax return.
Robin hands off the exemption to Terry with Form 8332. The IRS tends not to look behind Form 8332 so I think that Robin and Terry can do this on a handshake. Legal formalities could chew through eleven hundred bucks pretty quickly, but I’m not going to give you legal advice.
The Form 8332 shifts child tax credits, so Robin and Terry truing up and splitting the net gain might be a little complicated. That is where the cooperation and trust comes in. Form 8332 does not affect Head of Household filing status and the Earned Income credit.
Nonetheless consider Reilly’s Sixth Law of Tax Planning – Don’t do the math in your head. Run both returns both ways and look at them closely. And you will also have to consider how the child credit will work under the law that is currently working its way through Congress (American Rescue Plan Act of 2021-ARPA), which may include a monthly payment.
The requirement of trust, cooperation and transparency might make taking advantage of this windfall impossible for quite a few couples, but others will be able to make it happen.
On To 2021
Here is where it might go from good to great, but maybe not. Under ARPA, the upfront payment of $1,400 per dependent will be based on the 2019 return unless the 2020 return has already been filed. As with last year’s EIP, the true-up on the 2021 return only works in favor of the taxpayer. So possibly if Terry pushes hared to get the 2020 return out they will both get checks for $2,800 rather than $2,800 for Robin and $1,400 for Terry. But maybe not.
The bill calls for regulations or guidance to ensure that to the “maximum extent administratively practicable”:
…an individual is not taken into account more than once, including by different taxpayers and including by reason of a change in joint return status or dependent status between the taxable year for which an advance refund amount is determined and the taxable year for which a credit under subsection (a) is determined
Is it going to be “administratively practicable” for IRS to unscramble this egg? I have to let you make your own judgement on that. I would say that if you do score the extra $1,400, put it aside just in case.
For what it is worth, the first couple that I spoke to about this (Remember this is not just for divorced people. It is also for people who are together who never married, which is pretty common nowadays,) had some odd ball circumstances that made the strategy impractical. I picked up this idea from Andera Carr CPA on #TaxTwitter.
So far I have only heard from practitioners whose clients stumbled into the windfall, which as I noted would happen if they alternated taking the exemption. I don’t see any reason not to be proactive about it other than you would not bend over to pick up $1,100 if it meant that you had to talk to your ex, which in many cases is a perfectly good reason.
I have been a CPA for over 30 years focusing on taxation. I have extensive experience with partnerships, real estate and high net worth individuals. My ideology can