Dependents and your tax return

Got kids? We know that sometimes they can be jokingly referred to as, “our little tax deductions,” so let’s begin at the beginning.

When little Susie is born, her parents (you) must apply for a social security account number (SSAN) for her before you leave the hospital. In the case of a home birth, you must apply and receive a SSAN before you can claim her as a dependent on your tax return. The IRS requires you to list a social security number for each dependent you claim on your tax return. Susie now becomes “your little tax deduction” through age 18. If your child attends college/trade school for 5 calendar months they qualify as a dependent, as long as they are under age 24.

A dependent includes brother/sister, niece/nephew, parent, grandchild, step-relation, foster child, aunt, uncle, in-laws, or any other person who lived with you all year as a member of your household, age 19 or older not attending college/trade school, earning less than $3,900 per year. This person can still be claimed as a dependent if you are providing over half of their support.

Your dependent must live with you for more than half of the filing year.

The IRS allows a $3,950 exemption (reduces taxable income) for each person claimed (taxpayer, spouse and dependents).

You may claim at $1,000 tax credit (reduces your tax dollar for dollar), and may be refundable if the credit exceeds your tax liability for each child under 17.

The Earned Income Credit (up to $6,143) is a dollar for dollar reduction in tax, and may be refundable if it exceeds your tax, based upon your earned income (wages, self-employment income, combat pay, disability pay reported on form W-2) if you have limited (lower) income. Up to 3 children can be claimed if your filing status is married, single, head of household or qualifying widow(er).

With children of divorced or separated parents, it becomes complicated when considering who can claim the child as a dependent. The IRS matches the social security number of the child claimed as a dependent to make sure the same child is not claimed on more than one tax return.

In most cases, a child of divorced or separated parents may be claimed by the parent having custody of the child. However, the child may be claimed as a dependent by the noncustodial parent (the parent with whom the child lived the lesser part of the year) if all the following apply: (1) The parents lived apart at all times during the last six months of the year; (2) the child received over half his/her support from the parents, including a parent’s spouse, or step parent; (3) the child is in the custody of one or both parents for more than half the year; (4) the custodial parent signs Form 8332 Release of Claim to Exemption for Child by Custodial Parent, or a similar form for divorce/separation agreements from 1985-2008. After 2008 you must use Form 8332. If a pre-1985 divorce/separation agreement states the noncustodial parent can claim the child, and the noncustodial parent provided at least $600 support during the year, the noncustodial parent gets the dependency deduction.

The custodial parent is the parent with whom the child resides for the greater number of nights during the year. If the child lived with each of the parents an equal number of nights during the year, the parent with the higher adjusted gross income is the custodial parent.

Example: If Susie is attending school full-time she may qualify her parent(s) for the American Opportunity Credit or the Lifetime Learning Credit based upon their filing status and income level.

American Opportunity Credit (AOC) can be taken for tuition, books and materials for the first four years of higher education taken and can be worth up to $2,500 (100% of the first $2,000 of qualified expenses, and 25% of the next $2,000 of qualified expenses). 40% of the credit is refundable for most taxpayers.

Lifetime Education Credit for tuition and books, supplies bought from the institution the student is attending and provides a tax credit for 20% of the first $10,000 of qualified education expenses (maximum $2,000 per tax return, regardless of the number of eligible students). There are income limitations on this credit. (Only one of the above credits can be used.)

There is also a tuition and fees deduction of up to $4,000 as a reduction of taxable income (not a credit against taxes) with income limitations to qualify.

Remember to let your tax preparer know about the status of your dependents and how the above deductions and credits may help you. At Moats & Hebebrand CPAs we have the knowledge to sit down and thoroughly explain these tax options to you.