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Thank you for using just answer. This is a really good question. In order for you to claim your daughter under the Qualifying Child rules, you must be able to prove that you provided more than 50% of her support. If your daughter lived with you more than 6 months in 2007 before being incarcerated, then this should be no problem really. If she was incarcerated for the majority of the year, then meeting this requirement, once you consider meals, clothing, medical/dental and housing, will be much more difficult.
While this specific situation (an incarcerated dependent) is not mentioned in the tax law or IRS instructions, I based the scenario above on a Tax Court case from 2002 (T.C. Memo 2002-258 [PDF document]). The issue in that case was whether the parent could claim her son as a dependent and as a qualifying child for the earned income credit even though her son was in prison all year. The Tax Court reasoned that since the parent did not provide more than half of the child's support, the parent could not claim the son as a dependent. Furthermore, since the son did not live with his mom for more than 6 months of the year, the mom could not claim her son for earned income credit purposes.
I hope this helps you
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