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Prune your taxes by buying Junior a car

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in Small Business Tax

One added reason that it's hard to watch your children leave the nest is that you lose a coveted dependency exemption. In 2003, the exemption equals a $3,050 subtraction from your taxable income.

But here's a unique way to preserve that write-off one extra year, even if your child is now working full time: Give the child new wheels this holiday season.

Here's the story: You can claim a dependency exemption for children if (1) you provide more than half of their support for the year and (2) their taxable income doesn't exceed the personal exemption amount ($3,050 for 2003). Fortunately, the second part of the test doesn't apply to a child who is under 19 or a full-time student under age 24.

For instance, say your daughter graduated from college in May and landed a good job right out of school. You can still claim a dependency exemption for her this year as long as you pass the half-support test. (The value of lodging you provide to her counts as "support," so include that amount as support if she lived at home during the year.)

Advice: Run the numbers now. If you've provided less than half the support so far this year, giving your child a car as a gift can push you over the top.

The full value of the ultragenerous gift counts as support that you provide this year, even if you finance the car. Also, it doesn't matter if you give the car in December and your daughter uses it for only one day in 2003.

Example: Saving your exemption

Let's say that during 2003, you provided $15,000 in support to your 23-year-old son, who attends grad school at night. He earned $25,000 this year from his day job.

To reward his hard work and ambition, you want to give him a special gift at the holidays. So you put down $5,000 and buy your son a new $20,000 car. You agree to pay off the car over time.

The impact: The car's full cost counts as support for 2003. So now you've provided your son with more than half of his support for the year ($35,000 support compared with $25,000 of his income). As a result, you're able to take a $3,050 dependency exemption on the child when you file your 1040.

Final tip: Timing is everything. If it works out better in your situation, you may want to delay the gift until 2004, perhaps when your child graduates from college.

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