Who is a Dependent? It Depends!

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This week, we wanted to share with you a question that we have been getting quite frequently over the past several weeks now that it is tax time. With everyone getting ready to file 2013 taxes, the question we have been getting is: Who can I claim as my dependent on my tax return? Before we get into the “who” let’s talk about why this is important. I think most people have a general idea that being able to claim someone as a dependent can provide some tax benefits. However, I think a lot of you may be surprised to find out just what types of benefits you can get with dependents on your tax returns.

For example, most of you may be aware that your dependents can provide you with a tax exemption of $3,900 for the 2013 year as well as a child tax credit of up to $1,000. Having dependents may also allow you to become eligible to file as head of household. Many of you may not know that you can also claim a dependent care tax credit as well for taking care of dependents who are not your kids.

In the U.S. today, we are seeing more and more individuals taking care of not just their kids but their aging parents as well. So a taxpayer’s ability to claim dependent care tax credits for the care of aging parents can provide some tremendous tax savings. Also, your dependents may be eligible for coverage under an employer’s medical plan. These also include tax free medical savings accounts and health savings accounts.

Here is an example of how a dependent can save you money:

We have a client we will refer to as “Jim”. Jim has a real estate business and is a dedicated family man. For the past several years, he has been taking care of his aging father. Due to some health conditions, Jim’s dad incurs a pretty hefty medical bill each month for his rays and prescription medicines.

Jim was able to utilize the dependency exemption along with some proactive tax planning strategies through his business operations to take full advantage of the tax benefits of paying for his father’s medical expenses. This alone provided Jim with additional tax deductions of ~$9,500 that year in taxes. As you can see, claiming the right dependents doesn’t only provide you with your annual exemptions to deduct on your tax returns; it can also provide you with some great tax credits and other write-offs that you may otherwise lose out on.

So let’s go back to the question of “who is a dependent?” And your favorite answer of all time…

“It Depends!”

Ok, I know this is not your favorite answer but unfortunately, that is the answer to most tax questions. In this case, the answer to who is a dependent actually depends on who we are referring to. You see, there are different rules for the eligibility of determining who is a dependent. A dependent does not have to be your child. It does not have to be your parent. In fact, a dependent may not even have to be related to you. So let’s do our best to summarize for you the qualifications of who can be a dependent. Let’s first start with your children.

In order for your “children” to qualify there are 3 main tests:

1. The “child” lives with the taxpayer for more than one-half of the tax year. (excluding temporary absences such as military, college, etc.)

2. Is under age 19, or is a student under age 24, and

3. The child has not provided more than 50% of his or her own support during the tax year.

Here is the part that a lot of people may not know. When we think of “children”, we typically think of our sons and daughters, right? Well, thankfully, the IRS has a much broader definition for this term. Under the IRS, the definition of a “child” includes your stepchild, foster child, adopted child, niece, nephew, grandchild, and get this…your younger brothers and sisters too!

Next, let’s go over the dependency qualifications of a relative

The qualifications are as follows:

1. Their gross income for the calendar year is less than $3,900,

2. You provided more than 50% of the individual’s support for the tax year, and

3. They are not a qualifying child for another taxpayer.

What this means is that you can claim your relative as a dependent even though they did not live with you at all during the year! This is an often overlooked loophole that is very helpful for taxpayers who provide support for their aging parents who do not live with them.

Now let’s move on to the next category which is unrelated individuals:

The only difference between claiming a relative as a dependent vs. an unrelated person as a dependent is that the unrelated person must have lived with you for the entire tax year. So if you have a girlfriend or boyfriend who meets the criteria above, you may be able to claim them as your dependent as well.

With that said, please realize there are additional rules in regards to dependents that are married, dependents who are non-citizens of the U.S., divorced or separated parents, and taxpayers filing as Head of Household. If you would like more information on this, please speak with your tax advisor.

As we said before, we have been getting more and more calls in recent years on questions for dependents. It isn’t uncommon now a days to see families supporting adult parents or adult children, and then wondering: is there are any tax breaks in this type of situation? If you find yourself in a similar situation, then make sure you have a plan in place to take full advantage of the tax benefits that you may be legally entitled to…after all…it’s your money!

…thoughts?

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About Author

Amanda Han of Keystone CPA is a tax strategist who specializes in creating cutting-edge tax saving strategies for real estate investors. As real estate investors herself, Amanda has an in-depth understanding of the various aspects of investing including taxation, self-directed investing, entity structuring, and money-raising.

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