I constantly get asked, "When can I treat my sister,daughter, or parent as a dependent?"Surprisingly, there are a number of myths andmisunderstandings regarding this question. Butlike many tax law questions, the answer to this one isclear-cut: It depends. There are five tests that must bemet to claim someone as a dependent. If you cannotmeet one of these five tests for your tax year, the individualin question is ineligible to be your dependent.
The first of the five tests is the relationship ormember of household test. An individual passes therelationship test if they are one of the following:
Of course, there are exceptions to this list. A fosterchild or grandniece can be your dependent if they livedin your household for the entire tax year. If yourdependent has a certain relationship (eg, child or parent),they do not have to live in your householdthroughout the year. If you support your live-in girlfriendor boyfriend, they can also qualify. Although thetwo of you are not married, they can meet the memberof household test. As you can see from this example,someone does not have to be a relative to meet themember of household test.
In addition, every child born qualifies for a dependencyexemption, even if they only live for a shorttime. And only people can qualify as a dependent.Sorry, your dog doesn't qualify.
The second of the five tests is the gross income test.Generally, for a person to qualify, they can't make morein gross income than the dependency exemption. For2004, the dependency exemption is $3100. So, if Dr.Smith has a sister living with him, and the sister meets themember of household test but her gross income exceeds$3100, Dr. Smith cannot claim her as a dependent.
Sock It to the IRS
Interestingly, there are two exemptions from thegross income test. This test does not apply to childrenwho don't turn age 19 by Dec. 31 of the tax year orwho qualify as full-time students and don't turn age 24by Dec. 31 of the tax year. For example, Dr. Smith'sdaughter, Debbie, is age 15 and earned $200,000 thisyear acting in the movie . If Debbiebanks the money, Dr. Smith may still claim her as adependent since she is under age 19.
As for full-time student status, a full-time student issomeone who, during a 5-month period within the year(these 5 months need not be consecutive), is enrolled full-timeat an educational institution. However, a child whoattends school exclusively at night isn't considered a full-timestudent, although some night attendance is allowed.Also, students enrolled in a correspondence school or ahospital internship do not qualify.
The third test is the support test.Except for divorced or legally separatedparents, in which case some specialrules apply, if you're claiming a child asa dependent, you must provide overhalf of their total support. Supportincludes food; toiletries; lodging; clothing;recreation, such as camp and entertainment—coins for pinball machinesdo count as support; medical and dentalexpenses; gifts and allowances; weddingand bar/bat mitzvah costs; and alleducational costs.
Notice that you need to provide overhalf the support. If you have a child whomakes a lot of money, they shouldn't usethe money for support. It is vital that thismoney be put in the bank. You can thenshow the IRS that your dependent is notproviding over half the support. Also,remember that noncash items, such aslodging, constitute support. You wouldmeasure this by the fair market value.Get quotes from newspaper classifiedads to find out how much a room rentalwould normally cost.
In addition, you may claim a dependencyexemption for your child even ifthey live with your former spouse.However, you will need to obtain awritten support agreement. Therefore,it is necessary for you to see yourlawyer about this matter.
The fourth of the five tests is the citizenshipor residency test. The claimeddependent must be a US Citizen, US resident,American Samoan, or resident ofCanada or Mexico. Canada and Mexico must havehad one heck of a lobby to have its residentsincluded.
The fifth test is the joint return test.The dependent generally cannot file ajoint return with someone else, such astheir spouse. However, the IRS hasruled that if the dependent in questiondidn't make enough money to file areturn and only filed one to receive arefund, a joint return is allowed andthey can still be claimed as a dependent.
Unfortunately, what Congress gives,it takes. This is an example of tax simplification.In fact, when you hear theterms "tax simplification"or "taxreform,"these are code words for "stickit to the taxpayer."If your adjusted grossincome (ie, your wages, dividends, interest,and net income from business andpensions) exceeds $214,050 (married,filing jointly) or $142,700 (single), thenyour exemption amount phases out by2% for every $2500 ($1250 for marriedcouples filing separately) that you earnover these amounts.
In short, obtaining exemptions forall the people you support can greatlyalleviate some of your tax burdens. It's alot cheaper if the government subsidizesyou through deductions. You must,however, know the rules; otherwise, youcould lose out on a lot of deductionsthat are available to you.
a former IRS tax attorney and
trainer of IRS attorneys, is CEO of the Tax Reduction
Institute in Maryland and the author of
Lower Your Taxes—Big Time! (McGraw-Hill;
2003). He travels nationwide lecturing on tax planning
and audit-proofing techniques for small and
home-based businesses. He welcomes questions or
comments at 301-972-3600 or www.taxreductioninstitute.com.