HOW MANY EXEMPTIONS CAN YOU TAKE?

Yes, your kids and relatives depend on you. But what’s that worth at tax time? Here’s how to figure out a confusing point of tax law.

It looks so easy on the tax form, but it’s one of the most common mistakes that people make each year. We’re talking about “exemptions,” and who legally qualifies for these very valuable tax deductions.

You get an exemption for yourself, your spouse and, potentially, for all your dependents. But here’s the thing that confuses everyone: you can have a dependent who doesn’t qualify as an exemption.

Here are the standard deductions and exemptions that apply:

To qualify as a dependent, a member of your household must pass the following four tests. To qualify as an exemption, he or she must then pass a fifth test. But there are advantages to qualifying as a dependent that we’ll discuss later, even if you don’t meet the additional test to qualify as an exemption.

1.

Member-of-household or relation test. To meet this test, a person must either (a) live with you as a member of your household for the entire year, or (b) be a listed relative. Listed relatives include biological, adopted or stepchildren, siblings, half or stepsiblings, your ancestors, stepparents, aunts, uncles, nieces, nephews and in-laws; sorry, cousins or foster parents are not listed relatives.

Notice that under this test, even those who don’t qualify as relatives can qualify as members of your household, but they must live with you all year.

A child born during the year can still qualify as a dependent. So can someone who dies during the year, even on January 1!

 

2.

Citizenship test. To meet this test, the person must be a U.S. citizen or resident, or a resident of Canada or Mexico.

 

3.

Joint-return test. Normally, you can’t claim a person as a dependent if he or she files a joint return with somebody else. VERY IMPORTANT: this test doesn’t apply if the joint return was filed merely to claim a refund — and no tax liability exists for either spouse had they filed separate returns instead of the joint return.

For example, if your daughter files a joint return with her husband and each of them has earned $4,000, neither would have had to pay any tax, even if they had filed separate tax returns. If they file to get a refund of any withholdings, that doesn’t disqualify them under this test.

 

4.

Support test. You have to provide more than half the person’s total support for the calendar year. You can even pay support with borrowed money. Support is what’s spent, not what’s earned. If you have a dependent who won a million-dollar lottery and all that money was invested, you’ve still provided 100% of that dependent’s support.

 

What You Save With a Dependent

If you meet all of the above tests, you have a dependent. Remember, they still don’t entitle you to take an exemption deduction for them. But let’s look at what their being a dependent entitles you to claim at this point . . .

If someone qualifies as your dependent, you’re entitled to deduct all of his or her medical expenses — if you pay them (even if it is with money they give to you — see below). So you deduct all your dependent’s checkups, doctor visits, vaccines, medical insurance, etc.

If an aged parent qualifies as a dependent, you can also deduct all his or her medical expenses, including any expenses in a nursing home. Here’s where good planning can save substantial dollars.

If you have parents in a nursing home, they probably aren’t earning big dollars, and the deduction for their medical costs won’t save them much. However, if they gift the dollars to you (tax-free) and you write the checks, the deductions belong to you. Not only have you reduced your parents’ estates for Medicaid qualification in the future, but also now you can qualify for substantial tax savings.

If they’re in a nursing home for medical reasons, all of the payments qualify as medical expenses. If you’re paying $5,000 per month each, that’s a $60,000 medical deduction for each parent — and the deduction goes on your return! That’s even if they gift the money to you to pay for the expenses!!

Now, let’s qualify them for the exemption. To get that deduction, they must pass a fifth test . . .

5.

Gross income test. Gross income includes all income in the form of money, property and services. Tax-exempt income, Supplemental Security Income, and Social Security don’t count for this test. If your dependent is totally and permanently disabled, money received for services rendered at a sheltered workshop also doesn’t count.

To pass the Gross Income Test, your dependent can’t have gross income exceeding their exemption amount given above. If you fail this test, the person may still be a dependent (with the tax benefits described above), but you won’t get the exemption deduction.

But this is tax law, and for every rule, there’s typically an exception. This test doesn’t apply if the dependent is your child and is either (a) under 19 or (b) a student under 24. A “child” includes adopted and stepchildren, as well as a foster child who qualifies as a member of your household.

If the child is under 19, it doesn’t matter how much money that child makes. You still have to pass the support test, but that’s what's spent, not what’s earned.

To qualify as a student, your child has to go to school some part of just five months during the year. If your child has been in school since sometime in January, he or she meets the “student” classification even if the graduation is sometime in May.

Passing this test gives you the exemption deduction. But the amount you can deduct is phased out once your adjusted gross income (AGI) goes above a certain level.

You reduce the dollar amount of your exemptions by 2% for each $2,500 or part of $2,500 ($1,250 if you're married filing separately) that your AGI exceeds the following amounts:

If your AGI exceeds the levels above by more than $122,500 ($61,250, if filing separately), you get no deduction for your exemptions.