In 2000, each dependent provides a $2,800 tax deduction. In a 36% federal tax bracket, a $2,800 deduction saves you more than $1,000; state tax savings may make each dependency exemption even more valuable.
In essence, there are two types of people likely to provide legitimate dependency exemptions besides yourself and your spouse: young relatives and old relatives. For both types, certain tests must be met but two of these tests are crucial:
(1) You must provide over half the person’s support to get the exemption, and (2) the dependent’s gross income must be below the exemption amount: $2,800 this year.
- The gross income test is waived for all children up to age 18 and for full-time college students up to age 24. Thus, up until those ages the support test usually is the most important one you have to meet. In case of a divorce, which parent meets the support test? Generally, the custodial parent is the one entitled to the exemptions.
- Note: If the non-custodial parent is in a high bracket while the custodial parent pays tax at 15%, it makes financial sense to shift the exemptions to the high-bracket taxpayer, where they’ll do the most good. This can be attained if the custodial parent waives the right to the exemption on Form 8332; usually, this waiver will result from some consideration in the divorce negotiations.
- Once your child reaches age 24, the same support test applies: you must provide over half. Fortunately, you can include the fair rental value of any housing you provide as well as food, gifts, and so on.
- At age 24, the gross income rules also kick in. Thus, even if your child is still a full-time student you can’t take a dependency exemption if the youngster’s total income is over $2,800 for this year. That includes unearned investment income as well as earned income. So keep track and try to hold a child’s income under $2,800, if it’s close
- You also may be able to claim a dependency exemption for a parent or another elderly relative you have to support; the same income and support tests must be met. For this purpose, gross income does not include money that’s excludible from income. Thus, if your widowed mother’s Social Security benefits are untaxed, they won’t count towards the $2,800 limit. If your mother is just over the $2,800 threshold, even without Social Security it may make sense to switch her portfolio from taxable CDs or bonds to tax-exempt bonds or bond funds. Again, tax-exempt income doesn’t count for this test.
- You must provide more than half of your parent’s support during the year so you should track expenses carefully and make sure you reach the 51% mark, at a minimum. If your parent lives in your home, put a value on the housing you supply.
