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Who Are Your Dependents?

One of the most basic tax rules is also one of the most confusing and misunderstood. On tax returns for 2009 and 2010, each dependency exemption is a deduction of $3,650. In 2010, there is no longer any reduction in this amount if you are a "high-income" taxpayer. So the deduction can be significant; there is no limit on the number of dependency exemptions you can claim.

To be a dependent, the person must be a qualifying child, a qualifying relative, or a person designated as your dependent on Form 8832 (waiver of exemption by custodial parent) or 2210 (multiple support agreement). Here are some basic rules and how they operate in specific situations.


Qualifying Child

The tax law has six conditions for a child to be considered your dependent:

   1. The child must be your son or daughter, stepchild, foster child, or your grandchild. A child can also be your sibling or any of your sibling's children or grandchildren.
   2. The child must be one of the following three: (1) under age 19 by the end of the year and younger than you; (2) under age 24, a full-time student for at least 5 full months in the year, and younger than you (or your spouse); or (3) any age if permanently and totally disabled.
   3. The child must live with you for more than half the year, with some exceptions.
   4. The child must not provide more than half of his or her own support.
   5. The child, if married, does not file a joint return with his or her spouse unless it's only to obtain a tax refund.
   6. You, and not someone else, is entitled to claim the exemption (see the discussion about divorce below).


Qualifying Relative

For a dependency exemption for someone who isn't your qualifying child, four conditions apply:

   1. The person cannot be your qualifying child or a qualifying child of anyone else.
   2. The person must be either your relative or a person who is a member of your household.
   3. The person's gross income must be less than $3,650.
   4. You must provide more than half the person's support for the year.


Divorced, Separated, or Never-Married Parents

The dependency exemption can become complicated when parents divorce or separate, or were never married and both want to claim the exempt for a child of their union. Who wins?

Usually, the child is treated as a dependent of the custodial parent, who is the one with physical custody of the child. If parents share custodial, the parent with custody for the greater number of nights during the year is the custodial parent. If these nights are equal, then the parent with the higher adjusted gross income is the custodial parent. The noncustodial parent can claim the exemption only if the other parent signs Form 8332, waiving the custodial parent's right to the exemption.


Multiple Support Arrangements

When two or more individuals contribute to the support of another, who claims the exemption? It depends. As long as a person contributes more than 10% and the group contributes more than 50%, then any 10% contributor in the group may be eligible for the exemption. The group decides among itself who will claim the exemption and signs Form 2210, Multiple Support Declaration, to show this designation. The exemption in this case can be claimed for someone related to you or someone who lives with you for the full year as a member of your household.

Schedule L, Standard Deduction for Certain Filers

There are three deductions that in the past could only be used on the tax return if the taxpayer was filing Schedule A, Itemized Deductions.  These deductions can now be included on the tax return when the taxpayer is claiming the standard deduction.  These three deductions are:

• State or local real estate taxes paid in 2009.
• A net disaster loss reported on Form 4684, line 18 (Form 1040 filers only).
• State or local sales or excise taxes (or certain other taxes or fees in a state without a sales tax) paid after February 16, 2009, for the purchase of any new motor vehicle(s).

Schedule L is a new form beginning in tax year 2009 for taxpayers who are adding any of these deductions to the standard deduction and is required to be attached to the tax return.

Is this Income Taxable?

While most income you receive is generally considered taxable, there are some situations when certain types of income are partially taxed or not taxed at all.

To ensure taxpayers are familiar with the difference between taxable and non-taxable income, the Internal Revenue Service offers these common examples of items that are not included in your income:

• Adoption Expense Reimbursements for qualifying expenses
• Child support payments
• Gifts, bequests and inheritances
• Workers' compensation benefits
• Meals and Lodging for the convenience of your employer
• Compensatory Damages awarded for physical injury or physical sickness
• Welfare Benefits
• Cash Rebates from a dealer or manufacturer

Some income may be taxable under certain circumstances, but not taxable in other situations. Examples of items that may or may not be included in your income are:

• Life Insurance If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Life insurance proceeds, which were paid to you because of the insured person’s death, are not taxable unless the policy was turned over to you for a price.
• Scholarship or Fellowship Grant If you are a candidate for a degree, you can exclude amounts you receive as a qualified scholarship or fellowship. Amounts used for room and board do not qualify.
• Non-cash Income Taxable income may be in a form other than cash. One example of this is bartering, which is an exchange of property or services. The fair market value of goods and services exchanged is fully taxable and must be included as income on Form 1040 of both parties.

All other items—including income such as wages, salaries and tips—must be included in your income unless it is specifically excluded by law.
These examples are not all-inclusive. For more information, see Publication 525, Taxable and Nontaxable Income, which can be obtained at IRS.gov

Do I have to File a Tax Return?

You must file a tax return if your income is above a certain level. The amount varies depending on filing status, age and the type of income you receive.

Check the Individuals section of IRS.gov or consult the instructions for Form 1040, 1040A, or 1040EZ for specific details that may affect your need to file a tax return with the IRS this year.

Even if you don’t have to file, here are eight reasons why you may want to file:

Federal Income Tax Withheld If you are not required to file, you should file to get money back if Federal Income Tax was withheld from your pay, you made estimated tax payments, or had a prior year overpayment applied to this year's tax.

Making Work Pay Credit You may be able to take this credit if you have earned income from work. The maximum credit for a married couple filing a joint return is $800 and $400 for other taxpayers.

Government Retiree Credit You may be eligible for this credit if you received a government pension or annuity payment in 2009. However, the amount of this credit reduces any making work pay credit you receive.

Earned Income Tax Credit You may qualify for EITC if you worked, but did not earn a lot of money. EITC is a refundable tax credit; which means you could qualify for a tax refund.

Additional Child Tax Credit This credit may be available to you if you have at least one qualifying child and you did not get the full amount of the Child Tax Credit.

Refundable American Opportunity Credit This education tax credit is available for 2009 and 2010. The maximum credit per student is $2,500 and the first four years of postsecondary education qualify.

First-Time Homebuyer Credit The credit is a maximum of $8,000 or $4,000 if your filing status is married filing separately. The credit applies to homes bought anytime in 2009 and on or before April 30, 2010. However, you have until on or before June 30, 2010, if you entered into a written binding contract before May 1, 2010. If you bought a home after November 6, 2009, you may be able to qualify and claim the credit even if you already owned a home. In this case, the maximum credit for long-time residents is $6,500, or $3,250 if your filing status is married filing separately.

Health Coverage Tax Credit Certain individuals, who are receiving Trade Adjustment Assistance, Reemployment Trade Adjustment Assistance, or pension benefit payments from the Pension Benefit Guaranty Corporation, may be eligible for a Health Coverage Tax Credit worth 80 percent of monthly health insurance premiums when you file your 2009 tax return.

Highlights of the ARRA 2009: Incentives for Individuals

The American Recovery and Reinvestment Act of 2009 provides numerous tax breaks to individuals and businesses. It targets energy incentives to individuals and businesses, and provides fiscal relief for state and local governments that are facing large budget deficits.

Tax breaks and credit enhancements for individuals include a refundable “making work pay” credit, an increased firsttime homebuyer credit, enhanced earned income and child tax credits, a deduction for taxes paid on new vehicles, and an improved education credit. Also included in the Recovery Act is a one-year AMT patch.

Making Work Pay
The Making Work Pay Credit is a refundable income tax credit for tax years beginning in 2009 and 2010. The credit is the lesser of (1) 6.2% of the individual’s earned income, or (2) $400 ($800 for MFJ). This credit is available, in full, to workers with a modified AGI of $75,000 ($150,000 for MFJ) or less. Above that amount, the credit will be phased out at a rate of 2%. Note: The credit does not apply to any individual whose tax return does not include a Social Security
Number. An employee can take the credit through reduced wage withholdings or in a lump sum when filing his or her annual income tax return. An employer’s share of FICA (or its 6.2% equivalent) would remain unchanged. The credit applies to self-employment earnings to the extent that they’re considered in computing taxable income.

Economic Recovery Payment
Under the Recovery Act, certain fixed-income individuals (such as disabled veterans, railroad retirees, Social Security recipients, and certain government workers) will receive a one-time recovery payment of $250 in 2009. For individuals
who receive both this payment and the Making Work Pay Credit, the Making Work Pay credit will be reduced by the $250 payment.

First-Time Homebuyer Credit
For home purchases made after December 31, 2008, the new law raises the first-time homebuyer tax credit to $8,000 (from $7,500) and extends that credit to November 30, 2009. Any required repayments to IRS are eliminated after 36 months in the home. Phase-outs begin for individuals with AGI greater than $75,000 ($150,000 for MFJ) for the year of purchase. (Phase-outs apply for both 2008 and 2009.)
A taxpayer who bought a home on or after April 9, 2008, and before January 1, 2009, will not qualify for the new homebuyer credit; the purchase will continue to be governed by the original 2008 first-time homebuyer credit.

Temporary Tax Deduction on Car Purchases
Purchasers of new vehicles will get an above-the-line deduction for the state sales taxes, local sales taxes, and excise taxes paid. To qualify, a vehicle must be newly purchased for first use by the taxpayer and must (1) be a passenger vehicle, light truck, or motorcycle with a gross weight of no more than 8,500 pounds, or (2) be a motor home.

Deductible taxes cannot exceed the portion attributable to the first $49,500 of the price paid for any single vehicle. Phase-outs start for individuals with AGI greater than $125,000 ($250,000 for MFJ).

American Opportunity Tax Credit (Hope Credit)
The Hope Credit, which is being renamed to the American Opportunity Tax Credit, has been enhanced in the following ways under the new law:
• Amount increased to a maximum of $2,500 (from $1,800) per eligible student per year
• Modified rate of 100% of the first $2,000; 25% of the next $2,000, with a maximum $2,500 per year allowed on $4,000 in qualifying payments
• Forty percent of the credit will be refundable for 2009 and 2010
• Credit will now apply for all four years of college
• Qualifying expenses will now include course materials
• Phase-out level increased to $80,000 AGI ($160,000 for MFJ)

Qualified Tuition Programs (“529 Plans”)
For 2009 and 2010, a beneficiary of a qualified tuition program can use distributions to pay for computers and computer technology (including internet). Distributions will be tax-free. Previously, these expenses were not tax-free and were included in the beneficiary’s income and subject to penalty.

Earned Income Tax Credit
For 2009 and 2010, EITC percentage will be increased to 45% of the first $12,750 of earned income for taxpayers who have three or more qualifying children.( Prior to the new law, the credit percentage was 40% of the first $12,750 for taxpayers with two or more qualifying children.) In addition, the EITC phase-out range has been adjusted upward by $1,880 to eliminate any marriage penalty for joint filers.

Child Tax Credit
For 2009 and 2010, the refundable part of the child tax credit will be increased. The income threshold will now be set at $3,000.

Unemployment Compensation
Generally, a taxpayer’s gross income must include all unemployment compensation benefits received. Under the new law, in 2009 only, up to $2,400 of unemployment compensation will be excluded from gross income for federal income tax purposes.

Transit Benefits Parity
Transit passes, van pooling, qualified parking, and other qualified transportation fringe benefits are not typically included employee income up to a certain dollar amount. Under the new law, this dollar amount will be increased to $230 per month (up from $120) for transit passes and van pooling. This increased exclusion goes into effect in March 2009. It will continue through 2010 with adjustments made for inflation.

AMT Patch
The new law provides for an alternative minimum tax (AMT) patch for 2009. The following table shows the differences in exemption from 2008 to 2009.
AMT Patch Exemption Amounts 2008 2009
Joint filers and surviving spouses 69,950 70,950 (up $1,000)
Singles and heads of households 46,200 46,700 (up $500

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