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Gain a dependency exemption by paying a few dollars more

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in Small Business Tax

Do you help parents, in-laws or other elderly relatives with their living expenses? Maybe you occasionally pitch in with your relative's expenses, but you aren't able to claim a dependency exemption. Reason: You don't provide at least half of that person's annual support.

Strategy: Don't give up on a dependency exemption just yet. Add up all the support you provide the relative during the year. You may find that you're closer to the half-support mark than you thought.

In that case, giving the relative just a few extra dollars of support before Jan. 1—perhaps in the form of a holiday gift—can push you over the half-support threshold.

The law: You can typically claim a dependency exemption for a relative if you pass the "half-support test" and the relative's annual gross income doesn't exceed the personal exemption amount ($3,200 for 2005). The gross-income test doesn't apply to a child who is under age 19 or a full-time student under age 24.

The relative's gross income doesn't include amounts where income is deferred through CDs, Savings Bonds and growth stock. Nor does it include tax-free income generated by municipal bonds or muni bond funds. Key point: While Social Security benefits used for support count toward the half-support test, they do not count as gross income.

Example: Say you give Aunt Grace $1,000 in support each month to help with the rent ($12,000 each year). She is widowed and lives on $2,250 in taxable earnings and $12,000 of Social Security benefits. Aunt Grace stays with you for six weeks around the holidays.

Based on these facts, you wouldn't qualify for a dependency exemption.

However, if you include an extra $2,000 in support—the fair market value of food and lodging at your place—you're suddenly a lot closer to the half-support mark. By adding in this extra amount, you now provide $14,000 in support compared to the $14,500 of support that Grace provides for herself.

All you need to do is give Grace another $251 more in support and have her bank the same amount. New result: You provide more than half of her support—$14,251 to $14,250.

Bottom line: By giving Grace a $251 gift, you can secure a $3,200 dependency exemption. Not a bad trade-off.

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