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Barbara Weltman (Millwood, NY), an attorney, is a nationally recognized expert in taxation for small businesses. She has written extensively on tax, finance, and estate planning. Weltman is an experienced writer and is quoted regularly in major publications, including the New York Times and Boardroom's Tax Hotline. She is also featured on CNN and CNBC.
1. You and Your Family.
2. Medical Expenses.
3. Education Costs.
4. Your Home.
5. Retirement Savings.
6. Charitable Giving.
7. Your Car.
11. Real Estate.
12. Borrowing and Interest.
13. Insurance and Catastrophes.
14. Your Job.
15. Your Business.
16. Miscellaneous Items.
Appendix A. Items Adjusted Annually for Inflation.
Appendix B. Checklist of Nondeductible Items.
Do the old clichés still ring true? Can two still live as cheaply as one? Are things really cheaper by the dozen? For tax purposes, there are certain tax breaks for building a family.
This chapter explains family-related tax benefits, including:
Dependency exemption Child tax credit
Earned income credit
Dependent care credit
For more information on these topics, see IRS Publication 501, Exemptions, Standard Deduction, and Filing Information; IRS Publication 503, Child and Dependent Care Expenses; IRS Publication 504, Divorced or Separated Individuals; IRS Publication 968, Tax Benefits for Adoption; and IRS Publication 972, Child Tax Credit.
Each taxpayer (other than someone who is another taxpayer's dependent) automatically is entitled to a deduction just for being a taxpayer. The amount of the deduction, called the exemption amount, is a fixed dollar amount ($3,100 in 2004). However, if a taxpayer is considered to be a "high-income taxpayer," he or she loses some or all of this deduction.
You can claim a deduction for yourself, called a personal exemption.In 2004, the exemption amount is $3,100 (each year it is indexed for inflation). Table 1.1. shows you the value of your personal exemption for your tax bracket in 2004 (the amount of taxes you save by claiming it).
There are no conditions to claiming this deduction; it's yours because you are a taxpayer and the law says you are entitled to it.
Each spouse is entitled to his or her own personal exemption. On a joint return, two personal exemptions are claimed. If you are married but file a separate return, you can claim both deductions (an exemption for you and an exemption for your spouse) if your spouse has no income and is not the dependent of another taxpayer.
However, you cannot claim the personal exemption if you can be claimed as a dependent on another taxpayer's return. For example, a child who is the parent's dependent cannot claim a personal exemption on the child's own return.
If a parent waives a dependency exemption for a child, the child can then claim the exemption on his or her own return (the child is no longer treated as a dependent). This may be advisable, for example, when the parent cannot use an education credit because the parent's income is too high, but the child can use the credit to offset his tax liability (see Chapter 3).
High-income taxpayers may lose some or all of their deduction for exemptions as explained below (see Pitfalls). But the phaseout of personal and dependency exemptions is being eliminated. The reduction of this phaseout starts in 2006; there is no phaseout of exemptions by 2010. Note: Congress may accelerate the elimination of the phaseout.
You may lose some or all of the personal exemption (as well as dependency exemptions discussed later) if you are a high-income taxpayer. The write-off for exemptions is phased out for taxpayers with adjusted gross income above a set amount; once AGI reaches a set level, no write-offs are permitted. Table 1.2 shows where the phaseout of exemptions begins and the AGI level at which no exemptions can be claimed.
Once your AGI exceeds the beginning of the phaseout range, the deduction for personal and dependency exemptions is reduced by 2 percent for each $2,500 of AGI over the beginning phaseout number.
You cannot claim any personal or dependency exemption for alternative minimum tax (AMT) purposes, a shadow tax system designed to ensure that all taxpayers pay at least some tax. A large number of exemptions can substantially reduce or even eliminate any regular tax. So if you have a large number of exemptions, you may trigger or increase AMT liability. You may wish to engage in some tax planning to minimize or eliminate your AMT liability.
Where to Claim the Personal Exemption
You claim the exemption directly on your tax return in the "Tax and Credits" section of Form 1040 or the "Tax, Credits and Payments" section of Form 1040A; no special form or schedule is required. If you are filing Form 1040EZ, the exemption amount is built into the tax table (you can file this return only if you are single or married filing jointly with no dependents); you don't have to subtract it anywhere on the return.
If your AGI exceeds the beginning of the phaseout range, use a worksheet in the instructions for the return to figure the phaseout of your exemption.
A fixed deduction ($3,100 in 2004) is allowed to every taxpayer who supports another person and meets other tests described below. The deduction is called a dependency exemption. However, if a taxpayer is considered to be a "high-income taxpayer," he or she loses some or all of this deduction.
You may be entitled to a dependency exemption for each person you support if certain conditions are met. Like the personal exemption, each dependency exemption in 2004 is a deduction of $3,100.
There are five tests for claiming a dependency exemption. You must satisfy all of them:
1. Relationship or member of the household test.
2. Gross income test.
3. Support test.
4. Citizenship or residency test.
5. Joint return test.
RELATIONSHIP OR MEMBER OF THE HOUSEHOLD TEST. The person you claim as a dependent must either be a relative (whether or not they live with you) or a member of your household. Relatives who do not have to live with you in order to qualify as your dependent include:
Child, adopted child, or stepchild.
In-law (son, daughter, father, mother, brother, or sister).
Parent or stepparent.
Sibling, stepbrother or stepsister, half-brother or half-sister.
Uncle, aunt, nephew, or niece if related by blood.
Any other individual, including, for example, a cousin or foster child, must be a member of your household for the entire year (not counting temporary absences).
GROSS INCOME TEST. The person you claim as a dependent must have gross income of less than the exemption amount-$3,100 in 2004. However, if the person is your child, his or her income is disregarded as long as the child is under age 19 or under age 24 and a full-time student.
Gross income means income that is subject to tax. It does not include tax-free or excluded items, such as municipal bond interest, employee fringe benefits, or gifts. Social Security benefits are gross income only to the extent they are taxable (which may be 50 percent or 85 percent, depending on the recipient's income and Social Security benefits).
SUPPORT TEST. You must provide more than half of the person's support for the year (or meet the multiple support rules discussed later). Generally, this test does not present a problem; you may be the person's only means of support.
But where the person pays some of his or her own support while receiving help from you and other sources, you need to look closely at whether you pay more than half of the person's support. "Support" is different from "income." You need to look at what is spent on personal living needs and not what the person receives in the way of income. Government benefits payable to the person, including Social Security benefits, are treated as the person's own payment of support (whether or not actually spent on personal living needs).
EXAMPLES OF SUPPORT ITEMS
Education expenses (If your child takes out a student loan that he or she is primarily obligated to repay, the loan proceeds count as the child's own payment of support).
Lodging (If the person shares your home, support is based on the fair rental value of the room or apartment in your home, including a reasonable allowance for heat and other utilities).
Medical expenses (for details see Chapter 2).
Recreation, including the cost of a television, summer camp, dance lessons, and a wedding.
CITIZENSHIP OR RESIDENCY TEST. The person you claim as a dependent must be a U.S. citizen or national, or a resident of the United States, Canada, or Mexico.
JOINT RETURN TEST. If you are claiming an exemption for someone who is married, the person may not file a joint return with his or her spouse. However, this joint return test is not failed if a joint return is filed merely to claim a refund and both spouses have income under the exemption limit.
As described earlier in this chapter, elimination of the phaseout of the exemptions is scheduled to begin in 2006; by 2010, high-income taxpayers will no longer lose the benefit of personal and dependency exemptions.
MULTIPLE SUPPORT AGREEMENTS. Even if you do not provide more than half the support of another person, you may still qualify for the deduction if you contribute more than 10 percent of the person's support and, together with others, contribute more than half the person's support. Then each of the other supporters who contribute more than 10 percent must agree among themselves who claims the exemption (it cannot be prorated among the supporters).
In deciding which person should claim the exemption when more than one person qualifies, the decision should be based on who would benefit more. Factors to consider include:
Which person is in the higher tax bracket.
Whether such person is a high-income taxpayer subject to the phaseout of personal and dependency exemptions.
If all things are equal, then rotate from year to year who claims the exemption (for example, one year you claim the exemption for a parent and the following year your sibling claims it).
DIVORCED OR SEPARATED PARENTS. Where parents are divorced or separated, the dependency exemption for their child belongs automatically to the parent with whom the child resides for more than half the year ("custodial parent") as long as both parents together provide more than half the child's support. Entitlement to the dependency exemption does not depend on which parent paid the greater share of support.
If parents have joint custody under the terms of a divorce decree or written separation agreement, then custody for this purpose is based on physical custody of the child (where the child resides for the greater part of the year).
The custodial parent can waive the right to claim the exemption so that the other parent can claim it. The waiver may be year-by-year or permanent. The waiver must be made in writing (use IRS Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents).
In deciding whether to waive the exemption, the same guidelines for multiple support agreements discussed earlier apply here. It is highly advisable, however, that the waiver be made only on a year-by-year basis so that you can revisit the situation each year and make a fresh determination. This is especially important in light of the coming elimination of the phaseout of exemptions for high-income taxpayers.
For rules on the phaseout of the dependency exemption for high-income taxpayers as well as the impact of the AMT, see earlier sections of this chapter.
If you support a domestic partner or lover and meet all of the tests, you can claim a dependency exemption only if the relationship does not violate local law. For example, in North Carolina, a man was prohibited from claiming the exemption for his live-in girlfriend because under North Carolina law this cohabitation was a misdemeanor. In contrast, a man in Missouri was permitted to claim the exemption for his live-in girlfriend because the relationship there was not in violation of state law.
Where to Claim the Dependency Exemption
You claim the exemption directly on your tax return in the "Tax and Credits" section of Form 1040 or the "Tax, Credits and Payments" section of Form 1040A; no special form or schedule is required. You cannot claim a dependency exemption if you file Form 1040EZ.
If your AGI exceeds the beginning of the phaseout range, use a worksheet in the instructions for the return to figure the phaseout of your exemption.
Child Tax Credit
The U.S. Department of Agriculture estimates that it costs nearly $15,000 a year for a middle-class family to raise a child born in 2002 to age 17 (without adjustment for inflation). In recognition of this cost, you can claim a tax credit each year until your child reaches the age of 17. The credit is currently up to $1,000 per child. This credit is in addition to the dependency exemption for the child.
You may claim a tax credit of up to $1,000 in 2004 for each child under the age of 17. If the credit you are entitled to claim is more than your tax liability, you may be entitled to a refund under certain conditions.
Generally, the credit is refundable to the extent of 10 percent of earned income over $10,750 in 2004.
If you have three or more children for whom you are claiming the credit, you are entitled to an additional child tax credit. In reality, the additional child tax credit is merely a larger refund of the credit you are ordinarily entitled to. There are two ways to figure your refundable amount (the additional child tax credit) and you can opt for the method that results in the larger refund:
1. Ten percent of earned income over $10,750 in 2004. 2. Excess of your Social Security taxes (plus one-half of self-employment taxes if any) over your earned income credit for the year (the earned income credit is explained in the next main section).
To claim the credit, you must meet two conditions:
1. You must have a qualifying child.
2. Your income must be below a set amount.
QUALIFYING CHILD. You can claim the credit only for a "qualifying child." This is a child who is under age 17 at the end of the year and whom you claim as a dependent (explained earlier in this chapter).
The child need not be your own child-he or she can be a stepchild, grandchild, great-grandchild, sibling, stepbrother, stepsister, or descendant of any of these. For example, if you support your 15-year-old brother and claim him as a dependent on your return, he is a qualifying child.
Excerpted from J.K. Lasser's 1001 Deductions and Tax Breaks by Barbara Weltman Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Posted August 2, 2005
This book is wonderful. It was incredibly helpful. I am disabled and my husband is a truck driver.This book gave us so MUCH INFO about medical deductions, truck driving tax breaks, donations and how they can be used. It is VERY EASY TO READ and easier to use. It gives you the pro's and con's on what to deduct. It gives examples. I bought this book not expecting a lot. I was so suprised and happy with every part of it. For never having done my taxes by myself, this book made me feel very comfortable doing them. It also tells you how to keep track of necessary items for the following years taxes. I am extremely organized, but this book gave me a lot of great advice on how to better keep track of things.Thank you J. K. Lasser for creating this book. Here is hoping that you continue the great work.Was this review helpful? Yes NoThank you for your feedback. Report this reviewThank you, this review has been flagged.