Tax Exemptions and Deductions for Families
As a family, you may be able to save more on your taxes than a single person can. Once you discover all the deductions that are available to you, you'll be able to save more money this year, and plan better for your family's future.
If you're new to preparing your own income tax return, or if you just want to make sure you're taking advantage of every deduction that you're entitled to, this article is for you. We'll explain which deductions are available to your family, and also point out some deductions that many families overlook each year.
An exemption is an amount of money you can subtract from your Adjusted Gross Income, just for having dependents. Personal and dependent exemptions for yourself and qualifying family members reduce the amount of income on which you will be taxed. (in effect, these exemptions are the same as deductions).
In 2012, you can claim a $3,800 exemption for each qualifying child, which may include your child or stepchild, foster child, sibling or step-sibling, or descendants of any of these, such as your grandchild. To qualify for the exemption, the child must live with you more than half of the year and be under 19 at the end of the year, or under 24 and a full-time student for the year (defined as attending school for at least part of five calendar months during the year).
You no longer have to show that you provide more than half of the child's support, as was required under the rules in effect a few years ago. However, to claim an exemption the child cannot provide more than half of his or her own support.
There is no gross income test for a qualifying child. That means you can claim an exemption even if the child has a fair amount of income, as long as the child doesn’t provide over half of his or her own support, as outlined above.
You and your spouse are also each entitled to a $3,800 personal exemption.
For a married couple with three children, the total exemption deduction for 2012 is $19,000 ($3,800 x 5). If the marginal income tax rate for this family is 25 percent, the five exemptions save $4,750 in taxes.
Before 2010, higher-income taxpayers were subject to a phase-out rule that curtailed deductions for personal and dependent exemptions. That rule is gone for 2010, 2011 and 2012.
Note: If you are subject to the Alternative Minimum Tax (AMT), a parallel tax system that is increasingly affecting middle-income taxpayers, you cannot deduct personal or dependent exemptions. The disallowance of these exemptions under the AMT rules, is one factor that can push large families into the AMT.
Many families provide homes for relatives such as parents or grandparents, or support relatives who do not necessarily live with them. If you're in this situation, you can claim a 2012 dependent exemption of $3,800 for a qualifying relative who is not a qualifying child, as long as the supported person meets all five of these criteria:
- The person is either a relative or a full-time member of your household.
- He or she is a citizen or resident of the U.S. or a resident of Canada or Mexico.
- He or she did not file a joint income tax return with anyone else.
- You provided over half of his or her support.
- The person in question has less than $3,800 of gross income in 2012.
If your child is not a qualifying child for 2012 because he or she does not meet the age/student test or the residence test, you may still be able to claim an exemption for the child as your qualifying relative, but only if he or she has gross income under $3,800, and you provide more than half of his or her support.
A person who has lived with you for the entire year as a member of your household can meet the definition of a qualifying relative even if he or she is not actually related to you by blood or marriage. But if the person did not live with you for the entire year as a member of your household, the nature of the relationship becomes important.
Here's a list of people considered to be relatives by virtue of blood or marriage:
- Children, grandchildren or stepchildren
- Siblings, including half or step-siblings
- Parents, grandparents or any other direct ancestors
- Aunts or uncles
- Nieces or nephews
- Fathers-in-law, mothers-in-law, sons-in-law, daughters-in-law, brothers-in-law or sisters-in-law
There are special rules for persons receiving support from two or more individuals and for children of divorced or separated parents. If you are in this situation, read IRS Publication 504: Divorced or Separated Individuals.
The same person cannot be claimed as a dependent by more than one taxpayer, nor can a child who can be claimed as a dependent on his or her parents' return claim a personal exemption on his or her own return.
To claim anyone as a dependent, you must enter his or her Social Security number, or the equivalent, on your tax return. Using that number, the IRS software can tell fairly easily if two returns claim the same dependent, so make sure that you're entitled to the deduction before you prepare your return.
For more information, see IRS Publication 501: Exemptions, Standard Deduction and Filing Information.
You can deduct any expense you pay for the prevention, diagnosis or medical treatment of physical or mental illness, and any amounts you pay to treat or modify any part or function of the body for health—but not for cosmetic purposes. (So you can deduct the cost of LASIK eye surgery to correct your vision, but not the BOTOX® Cosmetic injections to smooth the wrinkles around your eyes.) You can also deduct the cost of transportation to the locations where you can receive this kind of medical care, your health insurance premiums, and your costs for prescription drugs and insulin.
Medical expenses are only deductible if you itemize, and only if they exceed 7.5 percent of your Adjusted Gross Income (10 percent if you are subject to the Alternative Minimum Tax). You can only deduct the medical and dental expenses that exceed those percentages.
Example: Emma's Adjusted Gross Income was $100,000, and she spent $8,000 on medical expenses. Because her expenses exceed 7.5 percent of her AGI, she can take the deduction for the amount above $7,500. Her deduction is $500.
Qualified long-term care expenses are treated as medical expenses subject to the 7.5 percent of AGI floor. Medical expenses also include the premiums you pay for qualified long-term care insurance. However, the amount of premium you can deduct is limited based on your age. For 2012, deductible premium amounts range from $350 to $4,370, depending on the covered person's age at year end.
There is an exception for qualifying health insurance premiums paid by eligible self-employed individuals. Such costs can be deducted as adjustments to income which means eligible taxpayers can deduct 100 percent of their qualifying health insurance premiums on page 1 of Form 1040. (In other words, this write-off is available whether you itemize or not.)
You can deduct medical costs you pay directly to medical service providers for another person according to the following rules:
- If you pay medical expenses for someone you do not claim as a dependent on your income tax return, you can deduct those expenses if:
- He or she either lived with you for the entire year as a member of your household.
- He or she is related to you (as described in the section Who's a Relative).
- He or she was a U.S. citizen or legal resident, or was a resident of Canada or Mexico, for some part of the year.
- You provided over half of his or her support for the year.
Note that these rules are slightly less stringent than those for the dependency exemption. For example, it's possible that you can deduct medical expenses you paid for a parent in 2012, even though you can't claim the parent as a dependent because his or her gross income exceeded $3,800.
- If you paid a person's medical bill this year for an expense incurred last year, and that person was your dependent last year, you can deduct the expenses on this year's return even if he or she isn't your dependent this year. The key factor is that the person was your dependent when the medical services were provided.
- If you're divorced and pay medical expenses for your child, but don't claim him or her as a dependent because you are the non-custodial parent, you can still deduct those expenses. This assumes that you would qualify to take a dependency exemption for your child is you were the custodial parent.
- You can deduct medical expenses that you pay for your spouse. What most people don't know is that you can claim medical expenses for your spouse's medical treatments that occurred before you were married if you paid those bills after your marriage. The rule is that you must be married either at the time of the medical treatments, or at the time the bills are paid.
For a complete list of qualified medical expenses, see IRS Publication 502: Medical and Dental Expenses.
In most cases, you can't deduct the full amount of your child's educational expenses because they are considered to be personal expenses. However, the following credits may help ease your tax burden:
- Deduction for college tuition expenses. This deduction is available to you regardless of whether you itemize your deductions. The maximum deduction is $4,000. The maximum deduction drops to $2,000 and then disappears completely as income rises. Expenses eligible for the deduction are higher education tuition and mandatory enrollment fees. These same expenses are also eligible for the American Opportunity tax credit but you can’t take both in the same year.
- American Opportunity and Lifetime Learning Credits. Available only for 2009 - 2012, the American Opportunity Credit is a tax credit of up to $2,500 for all four years of a college education. Single taxpayers with modified adjusted gross income (MAGI) of $80,000 or less and married taxpayers with MAGI of $160,000 or less are eligible. If the American Opportunity credit is not available, the Lifetime Learning credit might be allowed. It applies to tuition and mandatory enrollment fees for just about any post-secondary course. It is 20 percent of the first $10,000 of eligible expenses to a maximum of $2,000. MAGI limits are $60,000 for single taxpayers and $120,000 for married taxpayers filing jointly. For more information on higher education tax breaks, see IRS Publication 970: Tax Benefits for Education.
- Education Savings Accounts: Education Savings Accounts (ESAs) allow up to $2,000 each year to be contributed for each child under age 18. You can save a fairly sizable amount over several years .ESA contributions aren't tax-deductible, but you can withdraw your investment and earnings tax-free as long as you use the funds to pay for college costs. If your child chooses not to attend college, you can transfer the balance to another member of the family. You can use the money from an ESA to pay for elementary and high school education, as well as for college educational costs. The ability to make ESA contributions is phased out for higher-income taxpayers.
- Student loan interest: Interest on loans you take out to pay for college or vocational school expenses can also be deductible. The student loan interest deduction limit is $2,500 for qualified student loans, but the deduction is phased out for higher-income taxpayers. For 2012, the phase out begins at $120,000 on joint returns and at $60,000 for unmarried individuals.
- If you are the sole proprietor of your own business, consider employing your child (under the age of 18) for certain tasks. You can pay your child up to $5,950 in wages (the maximum standard deduction for the child for 2012) without incurring income taxes and most employment taxes. The wages would be tax-free to your young employee and you could deduct the wages as a business expense on your own tax return.
- If you have a child going to college in another area, consider purchasing a house or a condominium for your child to live in. By treating the house or condo as a second home, you can deduct the mortgage interest and real estate taxes on your own tax return.
TurboTax Deluxe Edition asks you simple questions about your family to make sure you get every deduction, credit and exemption you deserve.