Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, February 18, 1991 TAG: 9102160066
SECTION: BUSINESS PAGE: B/6 EDITION: METRO
SOURCE: JIM LUTHER ASSOCIATED PRESS
DATELINE: LENGTH: Long
However, the qualifications and exceptions to that rule are numerous.
For example, your dependent daughter can be as old as 23 if she is a full-time student. But if she is married and filing a joint return, you get no exemption. Unless, of course, she and her husband filed solely to get a refund and owed no tax.
It may be worth your while to pore through the rules because, depending on your tax bracket, each $2,050 exemption can save you up to $677 in taxes.
A dependent must meet five tests:
\ Relationship: A dependent must have lived with you throughout 1990 except for being temporarily absent due to school, military service, vacation or illness, or must be a relative. That can be a child, grandchild, stepchild, parent, grandparent, brother, sister, aunt, uncle, nephew, niece or in-law.
A live-in lover counts unless your state says it is illegal to have a live-in lover. Virginia does not recognize so-called common-law marriages. However, if the relationship was contracted in a state where it is recognized, Virginia would recognize it.
\ Income: In general terms, a dependent must have had a 1990 gross income under $2,050. That does not include tax-exempt income, such as welfare benefits and the non-taxable part of Social Security. Is the dependent your child? Then there is no income limit if he or she was under 19 at the end of 1990, or he or she was a full-time student and under 24 years at year end. Full time means a full class load as set by the school for at least five months of the year. A government-supervised on-farm training course also counts.
\ Citizenship: The dependent must be a U.S. citizen or resident alien or a resident of Mexico or Canada.
\ No joint return: As a rule, you may not claim an exemption for any person who files a joint return with another person.
\ Support: You must have provided more than half the dependent's financial support last year. This includes food, shelter, clothing, transportation, medical expenses, education, child-care services, recreation and spending money. Do not include life insurance premiums, scholarships or Social Security or income taxes.
If you and someone else - a brother, for example - combine to pay more than half the support of a dependent such as an elderly parent but neither of you alone pays more than half, you may claim the exemption by contributing more than 10 percent. The others then must sign Form 2120, a Multiple Support Declaration.
A divorced parent who does not have custody of a child may take an exemption if the other parent agrees in writing to give up the claim, or if the claim was authorized by a pre-1985 court order or agreement. These rules are tricky, however, so check IRS Publication 504 for details.
You begin losing any tax saving from personal exemptions once your taxable income - after subtracting exemptions and deductions - exceeds a certain level. For 1990, the benefit for a single person begins dropping after taxable income passes $97,620; for a couple filing jointly, the threshold is $162,770; for a head of household, it is $134,930.
You must calculate the phaseout of your exemptions on the work sheet at the bottom of the tax rate schedules, which are in the instructions accompanying your tax forms. The exemptions must be claimed on the front of Form 1040 before they can be phased out.
The government also has taken note of the growing number of women working outside the home by providing a tax break to offset some of the costs of child care.
Nearly 9 million couples and individuals claimed the dependent-care credit on returns filed in 1989; they saved almost $4 billion in taxes. Others benefited from tax-free child-care assistance provided by employers.
You are not allowed to claim full benefit from both the tax breaks. If you have the choice, you will have to calculate which is more advantageous.
Here are the basic options:
Tax-free treatment of up to $5,000 a year worth of day-care service provided by an employer: The assistance must be provided under a formal, written plan that does not discriminate in favor of those with higher incomes.
This can include a salary-reduction plan, under which your employer regularly takes a predetermined amount from your paychecks and sets the money aside in a special account from which child-care expenses are paid. However, remember that those dollars escape withholding for Social Security and income taxes.
A tax credit, which reduces your taxes dollar for dollar, of up to $720 for one child or up to $1,440 for two or more: The credit is calculated on a maximum of $2,400 of eligible expenses for one child or $4,800 for two or more children. The maximum credit is 30 percent and drops gradually as income rises, to a minimum of 20 percent for those with adjusted gross incomes over $28,000.
Any employer-paid assistance must be subtracted from eligible expenses before the credit is calculated.
Here are basic rules for figuring the credit:
\ Qualifications: You may be eligible if, to work or seek work, you have to hire someone to care for a dependent child who is disabled or under age 13. Also, the credit is available for care of any other dependent, such as an elderly parent, or a spouse who is not capable of self-care. You must have furnished over half the cost of maintaining a home for the dependent last year.
\ Your work: Whether you or your spouse work full time or part time, for yourself or for an employer, you may qualify. You and your spouse must have had earnings in 1990. The work requirement is met if one spouse was a full-time student during a part of each of five months during the year and the other worked.
\ Expenses: You may include services of a housekeeper, maid or cook but not a gardener or driver. Costs of the dependent's food and clothing are not eligible, although you may count the costs of feeding a live-in housekeeper. Also, you may include expenses of nursery school or day care outside the home for a child under 13, but only the portion that pays for care - not education.
There is a second limitation, in addition to the $2,400 or $4,800 ceiling, on the expenses on which the credit is calculated. The total of expenses may not exceed your earned income, that is wages, tips and the like, for the year. If you are married, these expenses are limited to the smaller of your earnings or your spouse's.
There's a caution. You may not claim the credit for any child-care payments made to your child under age 19 or to any person who can be claimed as a dependent by you or your spouse.
When you claim the dependent-care credit or employer-provided assistance, you must list on Form 2441 the name, address and identification number of the person or organization that provided the care.
There is more paperwork. In most cases, if you pay any household employee wages of $50 or more in any quarter, you must withhold Social Security taxes. That means that for 1990, you should have withheld 7.65 percent of the first $51,300 of wages, added another 7.65 percent as the employer's share, and submitted the money along with Form 942 to the Internal Revenue Service.
Also, if you paid $1,000 or more in wages during a quarter, you are liable for an unemployment-benefits tax of 6.2 percent of the worker's first $7,000 of cash wages.
IRS Publication 503 provides more information on dependent-care benefits and Publication 926 outlines your liabilities as an employer.
Working families with children and earnings as high as $20,263 also may qualify for a special tax break of up to $953. Known as the earned-income credit, this provision aims to offset at least part of the Social Security payroll tax paid by lower-income families. The tax credit drops as income rises above $10,750.
You may qualify if at least one dependent child lived with you for more than half of 1990 and you had some earned income - such as wages, tips and self-employment income. In addition, your earned income and adjusted gross income, which is total income minus alimony paid and employee business expenses, must have been under $20,264.
In general, the credit is available to a person who is married and files a joint return; who is a qualifying widow or widower, or who files as head of household.
Specific restrictions apply to each filing status and, with other details of the credit, are spelled out in Publication 596, which is free from the Internal Revenue Service. There also are special rules if you have a foster child.
The earned-income credit is especially beneficial because if you qualify and your credit exceeds your tax liability, the government will send you a check for the difference. Also, you may arrange to receive the credit in advance as part of your weekly paycheck.
Claiming the credit does not reduce eligibility for Medicaid or Aid to Families with Dependent Children.
Having a child with income can complicate your federal taxes.
There is something called the "kiddie tax," which could affect you if your child was under age 14 at the end of 1990. That child's unearned income - such as interest, dividends or capital gains - over $1,000 must be taxed at the parents' top rate, assuming that is higher than the child's rate. You may prepare a return for the child and include a Form 8615.
Or, if the child's total income was between $501 and $4,999 and solely from interest and dividends, you may include that income on your own return. In this case, you must attach Form 8814 to your return.
Taking the second option could raise your own tax bill. Adding your child's income to yours will increase your adjusted gross income and make it more difficult for you to deduct medical expenses and miscellaneous job-related expenses.
Remember that the "kiddie tax" applies only to investment income - not to money your child earns in exchange for services.
If the child can be claimed as your dependent, he or she will have to file a return if total income was at least $500 and included as much as $1 of interest or other unearned income. On the other hand, if the child had no unearned income and can be claimed by you, a return must be filed once total income reaches $3,250.
by CNB