Personal Exemption

Section 151 of the Internal Revenue Code allows a $3,400 personal exemption (a deduction from adjusted gross income) for a taxpayer and each of his or her qualifying dependents. In 2008, the increases to $3,500. The taxpayer must be a U.S. citizen or a resident alien in order to claim a personal exemption.

The ability to claim a personal exemption is contingent on the taxpayer’s status as a dependent. In general, if another person can claim the taxpayer as a dependent, then the taxpayer is denied a personal exemption on his or her own return. This is true even if the other person decides not to claim an exemption for the taxpayer.

The upside of this rule is that a taxpayer’s spouse is generally not considered a dependent; this interpretation of the Code makes it possible for each spouse to claim a personal exemption on a joint return. Each spouse can also claim a personal exemption on his or her own return if the couple elects to file separately. (For those interested, an individual filing a separate return–for example, a married individual filing separately or a head of household filer–may claim an exemption for his or her spouse only if the other spouse has no income and cannot be claimed as another taxpayer’s dependent.)

The personal exemption is reduced for high-income taxpayers. Given that the phaseout rules for the personal and dependency exemptions are the same, the reader is asked to read an earlier post to this web log, , for a full discussion. But for high-income readers desiring a quick and dirty calculation of their allowable exemption amount, click on .

Supplementary relevant articles on the personal exemption follow below:

Many happy returns, Roger

Dependents

In 2007, a taxpayer can claim a $3,400 exemption for each eligible dependent ($3,500 in 2008). A taxpayer’s dependent must be either (1) a qualifying child or (2) a qualifying relative.

The exemption amount is a deduction from adjusted gross income. Unfortunately, in 2007, 2008, and 2009, the dependency exemption is reduced, even eliminated, for high-income taxpayers. But in tax years after 2009, the dependency exemption phaseout for high-income taxpayers will be eliminated.

Specifically, in 2007, for joint filers and surviving spouses, the dependency exemption is reduced by 2% or one-fiftieth for each $2,500 or any fraction thereof in excess of a threshold amount starting at $234,600 adjusted gross income (AGI) and ending at $357,100 AGI, $195,500 to $318,000 AGI for head-of-household filers, and $156,400 to $278,900 AGI for single taxpayers. For married persons filing separately, the exemption for dependents is reduced by 2% or one-fiftieth for each $1,250 or any fraction thereof in excess of a threshold amount beginning at $117,300 and ending at $178,550 AGI. Note that the ceiling for joint filers is $357,100 not $359,600 because the rule “any fraction thereof” rounds up any amount in excess of the forty-ninth interval of the phase-out range (that is, $357,100) to $359,600, the fiftieth and final interval; the same logic applies to other filing categories.

In 2008, the phaseout threshold increases to $239,950 AGI for joint filers and surviving spouses, $199,950 for head-of-household filers, $159,950 for single taxpayers, and $119,975 for married taxpayers filing separately. To complicate matters, the dependency exemption phaseout is itself being phased out–it will be reduced by one-third in 2007 and two-thirds in 2008 and 2009.

Example: A married couple with one qualifying dependent files a joint return in 2007 and reports $265,000 in AGI. Without the phaseout, the couple would be entitled to $10,200 in dependency exemptions (one personal exemption each for husband and wife plus one for the qualifying dependent results in 3 exemptions @ $3,400). But since the couple’s $265,000 AGI exceeds the phaseout threshold amount of $234,600 by $30,400, the initial exemption amount of $10,200 will be reduced by 2% for each $2,500 in excess of the threshold. The $30,400 excess divided by $2,500 equals 12.16 intervals so we round up to 13 intervals for a 26% reduction (13 intervals in excess of the phaseout threshold amount @ 2%) of the initial $10,200 exemption amount to yield a tentative reduction amount of $2,652 ($10,200 - [0.26 x $10,200]). Next, the tentative reduction amount is reduced by one-third to produce a final reduction amount of $1,768 ($2,652 - 1/3[$2,652]). Then, we subtract the final reduction amount of $1,768 from the initial exemption amount of $10,200 and find that the couple can claim $8,432 in dependency exemptions for 2007.

A dependency exemption can be claimed for a qualifying child who passes all of the tests listed below:

  1. Citizenship test. At some time during the year, the child must be a citizen or resident of the U.S., a U.S. national, or a resident of Canada or Mexico. Adopted Child. In the year the adoption becomes final, a dependency exemption can be claimed even if the adopted child doesn’t meet the citizenship test. But if the adoption is pending, this exception doesn’t apply and a dependency exemption is available only if the child meets the citizenship test.
  2. Relationship test. A qualifying child is related to taxpayer as (a) a descendant of either the taxpayer or taxpayer’s child; (b) the taxpayer’s sibling, half-sibling, or step-sibling; (c) a descendant of taxpayer’s sibling, half-sibling, or step-sibling; (d) taxpayer’s stepchild; or (e) taxpayer’s legally adopted child or foster child placed with the taxpayer by an authorized adoption agency or by judgment or decree of a court with jurisdiction.
  3. Support test. The child must not provide over 50% of his or her own support for the calendar year in question. Common items that count as support for a qualifying child include food, clothing, education, recreation and entertainment, medical and dental care, transportation (including the cost of a car purchased by taxpayer but registered in child’s name), and the fair market value of lodging. Payments for life insurance premiums, scholarships received by a child, and the value of personal services performed for a child do not count as support. For purposes of the support test, the child’s funds and resources are not considered support unless they are actually used for support.
  4. Residency test. The child must have the same principal place of residence as the taxpayer for more than one-half of the calendar year. Temporary absences for school, illness, vacation, military service, and time spent at a juvenile detention center count toward the residency test. A kidnapped child under age 18 will pass the residency test unless the child is kidnapped by a family member. A child who lives in the taxpayer’s home but dies during the year will pass the residency test. And a child born during the year will pass the test if the taxpayer’s home is also the child’s home.
  5. Age test. The child must be under age 19 or a full-time student under age 24 at the end of the calendar year. To be considered a full-time student, the individual must be enrolled at least five months during the year (no requirement that the months be consecutive) at a qualified educational institution (usually an accredited college, university, or technical-vocational institute) or a qualified on-farm training program. The age test doesn’t apply if the individual is totally and permanently disabled at any time during the year.

Likewise, a dependency exemption is available for a qualifying relative who meets all of the requirements that follow:

  1. Citizenship test. At some time during the year, the qualifying relative must be a citizen or resident of the U.S., a U.S. national, or a resident of Canada or Mexico.
  2. Relationship test. A qualifying relative is related to taxpayer as (a) a descendant of either the taxpayer or taxpayer’s child, (b) the taxpayer’s sibling, half-sibling, or step-sibling, (c) a descendant of taxpayer’s sibling, half-sibling, or step-sibling, (d) taxpayer’s father, mother, or ancestor or sibling of either, (e) taxpayer’s stepfather or stepmother, (f) taxpayer’s son-in-law, daughter-in-law, brother-in-law, sister-in-law, father-in-law, or mother-in-law, or (g) a member of the household who lives at taxpayer’s residence for the entire year. Temporary absences for school, illness, vacation, military service, and time spent at a juvenile detention center count toward the residency test for household members. In addition, a household member who lives in the taxpayer’s home but dies during the year will pass the “residency test” for this category of dependents. Furthermore, a dependent who at birth becomes a household member will also pass the residency test.
  3. Support test. The taxpayer must provide over 50% of the individual’s total support for the year, with exceptions for dependents covered by multiple support agreements and children of divorced or separated parents. To repeat: Common items of support include food, clothing, education, recreation and entertainment, medical and dental care, transportation (including the cost of a car purchased by taxpayer but registered in dependent’s name), and the fair market value of lodging. But payments for life insurance premiums, scholarships received by a dependent, and the value of personal services performed for a dependent do not count as support. It is important to note that the dependent’s funds and resources are not considered when calculating the percentage of dependent’s support provided by the taxpayer unless they are actually spent for support. Multiple Support Agreements. In the event two or more individuals provide support for a dependent, it is not necessary that the taxpayer who claims the exemption pay over 50% of the total support if (a) no one person otherwise eligible to claim the exemption pays over 50% of the support, (b) the taxpayer pays at least 10% of the total support, and (c) each person other than the taxpayer who contributes more than 10% of total support signs a written declaration stating he or she will not claim the exemption. Child of Divorced or Separated Parents. In a contest wherein two or more taxpayers attempt to claim the same child as a result of divorce or separation, then a parent trumps a nonparent. If parents file separate returns, then the custodial parent dominates the noncustodial parent. (The custodial parent is defined as the parent with whom the child resides for the greater part of the year.) But if the child resides with both parents for the same amount of time, then the parent with the highest adjusted gross income wins the exemption. But a custodial parent may transfer the dependency exemption to the noncustodial parent by completing IRS Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents. Visit my Tax Forms page on the navigation menu above to see a copy of Form 8332.
  4. Gross Income test. The relative’s gross income must be less than the exemption amount ($3,400 in 2007 and $3,500 in 2008). For purposes of the test, a dependent’s gross income does not include tax-exempt income, including certain Social Security benefits and interest earned on tax-free municipal bonds. However, gross rental receipts do count as gross income, but the gross income test does not allow a deduction from gross income for the corresponding rental expenses (eat.go., property taxes, repairs and maintenance, etc.).
  5. Dependency test. The relative must not be the qualifying child of the taxpayer or any other taxpayer.

For a listing of individuals who qualify as dependents, click on .

Generally speaking, a taxpayer’s qualifying dependent cannot claim a personal exemption on his or her own return. This is true even if the taxpayer decides not to claim an exemption for the qualifying dependent.

Furthermore, a married individual who files a joint return cannot be claimed as a dependent by someone other than his or her spouse. However, a married individual who files a joint return may be claimed as a dependent by a non-spouse if the sole purpose of filing a joint return is to obtain a refund and neither spouse would have a tax liability had they filed separately.

A taxpayer seeking to claim a personal dependency exemption cannot be claimed as a dependent of another person. Joint filers benefit from this logic: A taxpayer’s spouse is not considered a dependent, and this fact enables each spouse to claim a personal dependency exemption.

Finally, the Internal Revenue Service is a stickler for details: if the taxpayer fails to provide correct Social Security or taxpayer identification numbers for each dependent, the taxpayer will lose the dependency exemptions and get a new, and higher, tax bill.

Additional relevant articles on dependents are listed below:

Many happy returns, Roger