Dependency Exemptions: Special Rules
One of the most basic write-offs in tax law is the dependency exemption ($3,900 per dependent for 2013; $3,950 per dependent for 2014) (Code Sec. 151(d)(1)). This deduction is supposed to offset some of the cost of supporting a child or other person. There is no cap on the number of dependency exemptions that can be claimed. However, a variety of specialized rules may limit the dependency exemption or impact who can claim the deduction for a certain dependent.
A taxpayer who claims a dependency exemption for a child may also be eligible for other tax breaks, such as head of household filing status, the earned income tax credit, the child tax credit, and the dependent care credit.
However, being eligible for a dependency exemption does not automatically guarantee eligibility for other tax breaks. This is because a child may entitle a taxpayer to an exemption because he or she is treated as a qualifying relative (Code Sec. 152(d)) but not as a qualifying child (Code Sec. 152(c)). An adopted child and a foster child can be treated as a qualifying child (the formalities of the relationship must be proven). A qualifying relative can include an individual with no blood ties, such as the child of a significant other. So merely claiming an exemption does not establish eligibility to other tax breaks.
For example, in one case, a taxpayer with no biological relationship to a minor he was supporting was able to claim a dependency exemption and use head-of-household filing status, but could not take an earned income credit and child tax credit (Cooper, TC Summary Opinion 2013-59). The earned income and child tax credits apply only to a qualifying child and, in this case, the minor was not a qualifying child because of his lack of any biological relationship to the child (the child was treated as his qualifying relative).
Taxpayers with adjusted gross income (AGI) over a threshold amount may lose some or all of their deduction for a dependency exemption (Code Sec. 151(d)(3)). The reduction is 2 percent of the exemption amount for each $2,500, or portion thereof, of AGI over the threshold amount ($1,250 for married persons filing separately); the threshold amount depends on filing status.
The threshold amounts for the start of the phase-out for 2013 (and 2014) are:
• Married filing jointly: $300,000 ($305,050)
• Head of household: $275,000 ($279,650)
• Single: $250,000 ($254,200)
• Married filing separately: $150,000 ($152,525)
College Students. A high-income parent may want to waive the dependency exemption. Doing so allows the student to claim the American opportunity or lifetime learning tax credit if otherwise eligible; the student cannot take a personal exemption. This strategy is useful if the parent is subject to the phase-out of the exemption and/or is barred from claiming an education credit because income exceeds eligibility limits and the student has taxable income that can be offset by the credit.
In the case of a child with parents who are divorced, legally separated, or never married, there is a special rule for determining which parent can claim the child as a dependent. As a general rule, the custodial parent—the parent with whom the child lives for the greater part of the year—is entitled to the dependency exemption. This rule applies as long as one or both parents provides over half the cost of the child's support and the child is in the custody of one or both parents for more than half the year.
Determining the custodial parent. In determining this, count the number of nights during the year that the child resided with a parent. Count temporary absences (e.g., a stay in a hospital or at summer camp) as nights with a parent if the child would otherwise have been there at that time.