Smith & Gesteland Quick Tip

Qualified Dependents Can Save You Tax Dollars

Are you taking advantage of all the dependency exemptions you're entitled to? If you have children living at home, it's easy to identify your dependents. However, when an extended family lives together under one roof, or a family supports someone living elsewhere, identifying dependents gets more complicated. According to the Wisconsin Institute of CPAs, here's what you need to know about making the most of your dependency exemptions this tax season.

In general, for 2004, each taxpayer may claim a personal exemption of $3,100.

If you are married and file a joint return, you and your spouse each claim a personal exemption. You can claim an exemption for your spouse, even if he or she died during the tax year, provided that you did not remarry. In addition, a taxpayer is entitled to an additional $3,100 dependency exemption for each qualified dependent. A child qualifies for an exemption, even if he or she is born on the last day of the year.

IRS Five Part Test
To qualify as a dependent for tax purposes, an individual must meet all five tests below.

1. The Citizenship Test
The person must have been a citizen of the United States or a resident of the United States , Canada , or Mexico .

2. The Relationship or Member of Household Test
The dependent must be a qualified relative or a member of your household for the entire year. If the dependent is a qualified relative -- including members of your immediate family or step family, foster child, immediate in-laws, aunts and uncles, grandparents, and first generation nieces and nephews -- he or she is not required to live with you. If the dependent lives with you, he or she does not have to be a qualified relative.

3. The Gross Income Test
The dependent's gross income must be less than the amount of the exemption allowance for the year ($3,100 in 2004). The gross income test does not apply if the dependent is your child who is less than 19 years old at the end of 2004, or less than 24 at year-end and a full-time student for at least five months of the tax year. The term "gross income" refers to taxable income items included in the dependent's tax return. Nontaxable Social Security benefits and nontaxable scholarship funds are not included.

4. The Joint Return Test
If the dependent is married, he or she cannot file a joint return with his or her spouse, unless (1) the income of each spouse is under the income limit for filing a return and (2) the return is filed for the sole purpose of claiming a tax refund.

5. The Support Test
You must be able to establish that you provided more than half the cost of supporting that person. Support includes the cost of shelter, food, clothing, education, health care, transportation, and similar necessities.

In calculating support an individual pays for him- or herself, include only amounts actually spent. Money the individual has available, but did not spend, is not included.

Special Rules For Special Cases
In the case of divorced parents, the general rule is that the custodial parent claims the dependency exemption even if the non-custodial parent paid most of the child support. However, the custodial parent may agree to waive the exemption by signing Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents. The non-custodial parent attaches this form to his or her return and claims the exemption.

If two or more persons together provide more than 50 percent of an individual's support, but no one member of the group provides more than half, the individuals may enter into a multiple support agreement. Under this agreement, the dependency exemption may be claimed by any person providing more than 10 percent of the individual's support. If you are that person, you must have each person who contributes over 10 percent sign IRS Form 2120, Multiple Support Declaration, which you submit with your tax return.

Exemption Phases Out
If you are a high-income taxpayer, your deductions for personal and dependency exemptions may be gradually phased out. For 2004, the phase out begins when a taxpayer's AGI reaches $214,050 for joint filers, $142,700 for single filers, and $178,350 for heads of household, and $107,025 for married individuals filing separate returns.

How To Claim An Exemption
To claim an exemption for a dependent, you must use Form 1040 or Form 1040A and include a social security number for each dependent.