Benefits under many employer plans are available for employees, spouses and tax dependents. When parents are married and living with their children, it is usually fairly simple to determine whether a child is a tax dependent—at least until the child is out of high school. The rules become more complicated if the parents are separated or divorced.
Under recently issued regulations, the IRS established rules regarding the manner in which divorced or separated parents can release the dependency exemption to the other parent for tax purposes. Under these rules, generally speaking, the custodial parent is entitled to the dependency benefitsexemption unless the custodial parent releases the exemption to the noncustodial parent. Generally speaking, only the parent who can take the dependency exemption can treat the child as a dependent for other tax purposes, such as for medical plans, dependent care plans and the like.
In a recent pronouncement, Revenue Procedure 2008-48, the IRS has provided some relief to divorced or separated parents. Under the Revenue Procedure, so long as the parents jointly provide more than one-half of the support of the child, either or both parents can treat the child as a dependent for purposes of providing tax-free medical benefits. This will allow either parent in most instances to cover the child under an employer’s medical or dental plan, obtain reimbursements under the medical flexible spending account established under the employer’s cafeteria plan, or obtain tax-free reimbursement of medical expenses under a health savings account (HSA) or a health reimbursement arrangement (HRA).
However, the pronouncement does not extend to dependent care flexible spending accounts. Under the regulations governing these accounts, only the custodial parent is permitted to set money aside and receive tax-free reimbursements for dependent care expenses. The noncustodial parent may not take advantage of a tax-free dependent care flexible spending account, even if the noncustodial parent incurs child care expenses during the time that the child stays with the noncustodial parent. This is the case even if the noncustodial parent is permitted to take the dependency exemption for the child because the custodial parent properly releases the exemption to the noncustodial parent.