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The 5 Tests You Must Meet to Qualify for Tax Exemptions
Excerpted from Beat an IRS Audit by James O. Parker ©2007
In addition to the personal exemption available to taxpayers and their spouses, exemptions may also be taken for dependents. However, they must meet the five dependency tests to qualify the taxpayer to take an exemption for them.
The Relationship Test
In order for a taxpayer to be entitled to take an exemption for someone as his or her dependent, that party must have either lived with him or her as a member of the party's household for the entire tax year or must be related to the taxpayer to the degree specified in I.R.C. §152. Those who are considered to be relatives of a taxpayer under the provisions of Section 152 are children, stepchildren, grandchildren, and great-grandchildren; brothers and sisters, including half brothers and sisters and stepbrothers and stepsisters; parents, stepparents, grandparents, and great-grandparents; aunts and uncles; nieces and nephews; parents and siblings of a spouse; and, sons-in-law and daughters-in-law. Any of the relationships created by marriage are not terminated by divorce or by the death of the taxpayer's blood relative.
The Citizenship or Residency Test
A person for whom a taxpayer wishes to take an exemption as a dependent must be a citizen or resident of the U.S., or a resident of Canada or Mexico. As long as the party meets this requirement for some part of the calendar year in which the taxpayer's tax year begins, the requirement of the test is considered met for the year.
The Joint Return Test
Generally, if a taxpayer is otherwise entitled to take an exemption for a dependent, but the dependent is married and files a joint return, the taxpayer will not be allowed to take the exemption. The lone exception to this provision is the situation in which a party's married dependent files a joint return with his or her spouse in order to claim a refund of taxes withheld from earnings, but would otherwise have such low earnings that no taxes would have been due for either of them if they had filed separate returns.
The Gross Income Test
In order to be entitled to take an exemption for a dependent, the dependent person cannot have gross income in excess of the amount of the exemption deduction. However, a parent is allowed to claim an exemption for his or her dependent child, regardless of how much the child earns, as long as that child is either under the age of 19 at the end of the year, or under the age of 24 at year's end and a full-time student for at least five calendar months during the calendar year. Even though parents may be allowed to take an exemption for dependent children with incomes of their own, the result will be that the children will not be allowed to take an exemption for themselves on their own returns.
The Support Test
To qualify to take an exemption deduction for a dependent, a taxpayer who is otherwise qualified to take the exemption must usually provide more than half of the support for that person. However, there are two exceptions to this rule.
Multiple Support Agreements
If two or more otherwise qualified people together provide over 50% of a party's support, but no individual person provides the party with over half of his or her total support, any otherwise qualified person who provides over 10% of the party's support may claim the exemption for the dependent, as long as every other qualified party who provided over 10% of the dependent's support signs a Form 2120, which is a Multiple Support Declaration, stating that they will not claim the exemption for the dependent. An executed Form 2120 from each otherwise qualified party who is not taking an exemption for someone that they provided over 10% of their support to must be included with the tax return of the taxpayer who does claim an exemption for the dependent. Taxpayers should keep a copy of each Form 2120 for their own records, as well.
Children of Divorced or Separated Parents
Normally, if a child's parents are divorced, legally separated under a written separation agreement, or they lived apart for the last six months of the calendar year, the parent who had custody of the child for the larger part of the year will be considered to have
provided over half of the child's support and will be entitled to claim the child as a dependent for tax purposes. This rule will not apply if the noncustodial parent can show that he or she actually provided over half of the child's support for the year. If there is a
divorce decree or a decree of separate maintenance that states which party will be entitled to claim an exemption for a couple's dependent child, the decree will govern.
Audit Aspects of Tax Exemptions
There are a couple of situations in which exemptions can trigger an audit. The first is when more than one person claims the same person as a dependant for an exemption. In order to be allowed to take an exemption for a dependent, a taxpayer must supply the IRS
with the claimed dependent's Social Security number and describe the relationship between the parties. The IRS automatically cross-references Social Security numbers to detect situations in which more than one taxpayer has claimed a person as their dependent. When this occurs, the IRS will contact the parties involved to make a determination as to whom, if anyone, is entitled to claim the exemption.
The second occurs when the taxpayer is in a relatively high tax bracket. Taxpayers with relatively large incomes must reduce their allowance for exemptions. Taxpayers whose incomes exceed a statutorily set threshold amount must reduce their exemptions deductions by 2% for every segment of $2,500 that their income exceeds the threshold amount, up to a maximum of 100%. The threshold amounts are adjusted for inflation each year and reflected in a worksheet, provided in the Form 1040 instructions, for calculating the exemption deduction phaseout. If a taxpayer fails to make the required adjustment, the IRS will recalculate the taxpayer's tax liability and notify him or her of the recalculation and resulting tax deficiency.