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