How Is the Dependent Exemption Calculated?
One of the ways many taxpayers reduce their income tax bill is by taking an exemption for each dependent they're eligible to claim. The nice thing about taking dependent exemptions is there's nothing to calculate. However, you will need to make sure that you satisfy either the qualifying child or qualifying relative requirements for each dependent exemption you report on your return.
How Exemptions Work
The Internal Revenue Service lets you take one dependent exemption for each qualifying child and qualifying relative, as well as one personal exemption for yourself and one for your spouse, if you are filing a joint return. These exemptions offer the same tax savings as a deduction in that they reduce your taxable income. Getting your taxable income as low as possible with exemptions is always beneficial since you'll end up paying less tax on the money you earn – especially if they keep you out of a higher tax bracket.
How to Claim the Exemption
To take the exemption, you'll need to file the 1040 or 1040A form since the 1040EZ doesn't allow for dependency exemptions. When you file your taxes, you'll simply list the name, Social Security number and relationship you have with each dependent you want to claim an exemption for. On the second page of both tax forms there is a specific line to report the total exemption amount, which is the number of dependents reported multiplied by the fixed amount for the year.
Exemptions Are Fixed
There isn't much to think about as far as the exemption amount you're eligible for. This is because the dependent exemptions, as well as the personal exemption, are fixed in amount each tax year. In other words, every taxpayer who claims a dependent will report the same exemption amount. Each tax year, the federal government increases the exemption amount for inflation. For example, in 2010 the exemption amount was $3,650, but has been increased for inflation to $3,900 for the 2013 tax year.
Qualifying Child Rules
Of the two types of dependents, exemptions for qualifying children are more common since this category covers your children, stepchildren, foster children and any descendant of the three. It also includes siblings and their descendants. All of these individuals must be under age 19, but if they attend school full time, they remain eligible until they turn 24. Each dependent must live with you for more than half of the tax year. And although there's no requirement that you financially support a qualifying child, the rules prevent you from taking an exemption if the child provides more than half of the funds for his own support. Lastly, an individual who files a joint return with a spouse except to obtain a tax refund of tax already paid is ineligible to be a qualifying child.
Qualifying Relative Rules
You may be eligible to take a dependent exemption for adults and even children who aren't eligible under the qualifying child rules if they can be treated as a qualifying relative. To claim someone as a qualifying relative, you must contribute more than half of the funds necessary to support the person. However, the relative's gross income – the income that's reportable on a tax return – must be less than the exemption amount for the year. If your relationship to the dependent isn't one of the eligible familial relationships, the person must reside with you for the entire tax year before you're eligible to claim her as a dependent.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.