I have a similar situation, I think.
I supported a child (not by court order) for the entire duration of tax year 2007. The child's father provided no support whatsoever (financially or residence). The child is a US citizen and had no income (he was 4 years old).
The child's mother and father were never married, and the child's mother also lived with me. She had no income, and did not file a tax return. She's been pursuing a child support order for nearly two years now, but apparently Illinois (where we live) and Georgia (where the father lives) don't work very well together. There was no court ordered child support agreement in place in 2007, and the father provided exactly $0 in financial support to the child.
I claimed the child as a dependant on my federal 1040, as did the child's father.
The IRS sent me a letter asking me to double check the SSN of the child to see if there was a mistake; there isn't! When I talked with the IRS help line, they told me that the child qualified as a dependant of the father, not me.
Do deadbeat dad's really have the right to claim children that they don't support simply because they planted their seed and dumped the child's mother?
The child cannot be a dependent of the father because the mother and father combined did not provide more than 50% of the child's support and because they mother did not provide the father a signed form 8332. Whoever you spoke to at the IRS did not give you a correct answer (unfortunately, that happens sometimes)...or perhaps you did not give the IRS agent you spoke to enough information to get a correct answer.
It was appropriate for you to claim the child, however you were not eligible for the child tax credit or for EIC. You were only eligible for the dependency exemption.
My recommendation is that you send a letter in response to the letter that you received from the IRS (attached to a copy of the letter you received from the IRS) outlining the following:
The child's mother had no income but has physical custody of the child. The child's custodial parent did not provide a signed form 8332 to the child's father. The child's father provided no support of any kind to the child. The child and the child's mother lived with you for the entire year of 2007, and you provided all support for the child. You may eventually be required to provide proof that the child lived with you for all of 2007.
I cannot guarantee that you will win this one. You should, because dad certainly can't prove that the child lived with him or that he supported the child in any way, or that mom supported the child, or that mom signed a form 8332 allowing him the exemption. However, sometimes there just isn't enough proof available on your end, and sometimes the cost of battling the case outweighs the benefits of the exemption.
However, any investigation should absolutely disallow the exemption to dad...because dad absolutely has no proof of his right to the exemption.