IRS Provides New Guidance on the Tax Treatment of Dependents of Divorced / Separated Parents for Certain Employee Benefits

September 11, 2008

The Internal Revenue Service (“IRS”) has recently provided new guidance that will allow a child of parents who are divorced, separated or living apart to be treated as the dependent of both parents.

In general, the IRS does not allow non-custodial parents to claim children as dependents for purposes of the dependency tax exemption. Under Internal Revenue Code Section 152(e), a child of divorced or separated parents will only be treated as a dependent of a non-custodial parent for tax exemption purposes if the custodial parent provides a written declaration that he or she will not claim the child as a dependent for the tax year. Additionally, the non-custodial parent must attach a copy of this declaration to his or her tax return.

However, in Revenue Procedure 2008-48 released in August 2008, the IRS indicated that it will treat a child as a dependent of both parents under certain circumstances that are generally related to medical expenses, medical coverage and certain other employee benefits, irrespective of whether or not the child’s custodial parent has provided the written declaration described above.

Covered Benefits / Income

More specifically, under Revenue Procedure 2008-48, the IRS will treat a child as a dependent of both parents, absent a declaration of the custodial parent, for the following federal income tax purposes:

  • Exclusions from gross income for employees for certain employer-provided medical reimbursements, including expenses incurred by employees for medical care of a spouse and dependent children (Code Section 105(b));
  • Exclusions from gross income for contributions made on behalf of employees, their spouses and dependent children to an accident or health plan (Code Section 106(a));
  • Exclusions from gross income for “no-additional cost services” that an employer provides to employees, their spouses and dependent children as fringe benefits or qualified employee discounts (Code Sections 132(a) and 132(h)(2));
  • Deductions for medical expenses, including medical expenses of a taxpayer’s spouse or dependent children (Code Section 213(a)); and
  • Exclusions from gross income for distributions from Archer Medical Savings Accounts and Health Savings Accounts that are used to pay for qualified medical expenses of the beneficiary, the beneficiary’s spouse and dependent children (Code Sections 220(f)(1) and 223(f)(1)).

Covered Taxpayers

In addition, Revenue Procedure 2008-48 applies and is limited to taxpayers who:

  • Are divorced, legally separated under a decree of divorce or separate maintenance, legally separated under a written separation agreement or live apart at all times for the previous six months of the calendar year; and
  • Are the parents of a child who:Receives over one-half of the child’s support during the calendar year from the child’s parents;Is in the custody of one or both parents for more than one-half of the calendar year; andQualifies under Code Section 152(c) or 152(d) as a qualifying child or qualifying relative of the child’s parents.
  • Receives over one-half of the child’s support during the calendar year from the child’s parents;
  • Is in the custody of one or both parents for more than one-half of the calendar year; and
  • Qualifies under Code Section 152(c) or 152(d) as a qualifying child or qualifying relative of the child’s parents.

Effective Date

The guidance in Revenue Procedure 2008-48 is effective as of August 18, 2008. However, taxpayers may apply the guidance to any tax year beginning after December 31, 2004 and receive a credit or refund under Code Section 6511.

Impact

As a result of this guidance:

  • Employers will be able to provide coverage to non-custodial children without requiring a written declaration from the custodial parent allowing the coverage. This should reduce the paperwork requirement and ease the administration of health and welfare benefit plans.
  • Non-custodial parents will be able to exclude from their income any reimbursements or the cost of the employer providing coverage.
  • Employers should inform employees that children may participate in employer-provided “no additional cost services” regardless of whether employees have custody of their children.
  • Finally, employees may take distributions from their Archer Medical Savings Accounts and Health Savings Accounts to pay for the qualified medical expenses of their non-custodial children without including these distributions in their gross income.

For further information or help analyzing the impact of this new IRS guidance on your employee plans and pay procedures, please contact any member of the McGuireWoods Employee Benefits or Labor & Employment Teams.

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