Unfortunately, you can’t claim a dependency exemption ($3,900 for 2013) for an elderly relative you help support, unless you pass a two-part test.
Strategy: Take stock of your situation at midyear. Some smart tax planning might salvage an exemption without breaking the bank.
The payoff may be due to a little-noticed tax loophole involving Social Security benefits.
To qualify for the dependency exemption, (1) the relative can’t have gross income more than the personal exemption amount $3,900 for 2013, and (2) you must provide more than half of the relative’s support. Usually, it’s the first part of the test that trips up taxpayers trying to claim exemptions for elderly relatives. (The gross income limit doesn’t apply to children under age 19 or full-time students under 24.)
But Social Security benefits don’t count as “gross income” for this purpose even though they’re figured into the support equation. As a result, just a few extra bucks may put you over the half-support mark for the year.
Example: Your 80-year-old Uncle Sal receives $3,700 in taxable interest and $10,000 in Social Security benefits annually. Currently, you give Sal $300 a month for living expenses. As things stand now, you’ll provide $3,600 of Sal’s total support of $7,300.
Better approach: Give Sal an extra $100 and have him bank the $100 of savings. Now you pass the half-support test ($3,700 of a total $7,300) and can claim a $3,900 exemption for him.
Tip: Personal and dependency exemptions are reduced for certain upper-income taxpayers.