IRS eases rules for divorced/separated parents to claim tax-favored medical or fringe benefits for their child

The IRS will no longer deny the right of either divorced or separated parent to claim various tax benefits for their child, even if the Tax Code only gives the dependency exemption to the custodial parent. This new concession represents a limited exception to the otherwise blanket rule that, in the absence of a release of the personal exemption by the custodial parent, only the custodial parent can deduct expenses or exclude benefits for his or her child under the medical expense and fringe benefits rules.

What's changed

Tax Code Sec. 152(e) used to treat both parents that were divorced, separated or living apart as eligible to treat the child as a dependent. However, changes to the law by the Working Families Tax Relief Act of 2004 and the Gulf Opportunity Zone Act of 2005 now require that the custodial parent execute a release; otherwise, the noncustodial parent cannot treat the child as a dependent. The IRS has now explained that, despite the changes to Code Sec. 152(e), both parents can continue to treat the child as a dependent when deducting or excluding medical and fringe benefits.

Benefits affected

The expanded treatment of the noncustodial parent as the parent eligible to claim deductions or exclusions applies to the following benefits:

• Medical reimbursements;
• Employer-provided health insurance;
• Fringe benefits for no-additional-cost services and qualified employee discounts;
• Medical expense deductions; and
• Exclusions for distributions from medical or health savings accounts (MSAs or HSAs).

The relief in this new IRS rule applies immediately, beginning August 18, 2008. However, the parents may apply the relief to any tax year beginning after December 31, 2004, as long as the statute of limitations for claiming a refund has not expired.

(Rev. Proc. 2008-48)