Besides the personal and spousal exemptions, you should also claim an exemption for each of your dependents. The reason is that unless your dependent had taxable income of at least $20,000 in 2010 they will not be able to use the entire $2,500 of education tax credits because their income tax will be less than $2,500. However, your child must realize they may not claim themselves when you claim them as a dependent. If they do take a personal exemption for themselves, then they would have to file an amended return if you wanted to claim them as a dependent on your return. Spadea & Associates, LLC would gladly assist them in amending their return.
Briefly, if the individual meets all of the following tests, he or she is your dependent and is not permitted to claim an individual exemption on his or her own tax return:
Member of Household or Relationship Test
If your child or other dependent died during the year but would otherwise have met all five tests, you can still claim the exemption for the dependent. Conversely, if your child was born on the last day of the year and met all five tests above you can claim him or her them as a dependent. If the individual is not a close relative under the IRS’s definition, he or she can still meet the first test for dependent status by living with you for the entire year as a member of your household.
Foster children (or adults) can be treated as dependents if they live with you for the entire year, unless you receive payments as a foster parent from a state government, a political subdivision, or a tax-exempt child-placement agency. If you receive any such payments, you can’t claim a dependency exemption for the child. If you receive some payments as a foster parent, you can claim a charitable deduction for the excess expenses, if your actual expenses for the child are higher than the amount of payments you receive.
This test for dependent status is met if the person is a U.S. citizen or resident alien, or is a resident of Canada or Mexico for at least part of the calendar year in which your tax year begins.
Joint Return Test
This test for dependent status refers to the tax return filed by the dependent, not your own tax return. In most cases, you can not claim a dependency exemption for any married person who files a joint return with his or her spouse. The exception to this rule is if neither the dependent nor his or her spouse is required to file a tax return, but they file one merely to get a refund, and neither the dependent nor his or her spouse would owe any tax if they filed separately rather than jointly.
Gross Income test
The dependent must either (a) be your child who is age 18 or younger, or under the age of 24 and a student, or (b) have gross income that is less than the amount of the dependency exemption for the year, which means less than $3,650 for 2010.
Therefore even if your child was over 18 and in college and earned more than $3,650 in 2010, you should still claim that child on your return if you provided more than half of their support and you are in a higher tax bracket. The reason is that you can take advantage of the $1,500 Hope Education credit and $1,000 American Opportunity Credit which your child may not be able to use because they may not have enough taxable income to get the full education credit as stated earlier.
Remember the education credits are not refundable tax credits like the Earned Income Credit so if your child does not owe tax of less than $2,500, they will not be using the entire education credit that you would be eligible for assuming you are in a higher tax bracket.
The final part of the test for dependent status requires that you provide more than half of the person’s total support during the calendar year.
Planning Point for Self Employed Parents
If your child is 15 or older you can hire him or her and pay them up to $3,650 in 2010 and they will pay no income tax and you can still claim them as a dependent.
However, household employees or foreign exchange students that live with you will not qualify as dependents.