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Claim a dependency exemption by pooling family resources

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in Small Business Tax

Even though the tax rules for dependency exemptions were tweaked last year, you can claim an exemption for an elderly relative only if you provide more than half of his or her annual support.

Thus, if you and a sibling jointly support Mom or Dad, it’s likely that neither one of you will be entitled to the exemption.

Strategy: Create a multiple-support agreement. That way, you pool all the money used to support the relative and, if you meet certain tax-law requirements, one of you will be able to claim a $3,300 exemption for 2006.

Typically, you might trade off the exemption year to year.

Suppose that you, your sister and your brother collectively support your mother. You can take the exemption for Mom this year, your sister takes it next year and your brother takes it the year after that. Then, you start the cycle all over again. To qualify for this tax break you must satisfy the following requirements:

• The relative must receive more than half of his/her support from the family.

• Each of you must be able to claim the relative as your dependent except for the half-support test.

• No one individual can contribute more than half of the relative’s support.

• If you’re the one taking the exemption, you must provide more than 10 percent of the relative’s support.

• Anyone else contributing more than 10 percent of the support must agree not to claim the exemption.

The IRS makes things easy for you. Just fill out and file Form 2120 (Multiple Support Declaration). Find it at

Another wrinkle: You can’t claim a dependency exemption for someone who has more than the personal exemption amount ($3,300 for 2006) in taxable income. That means you might have to shift some of the relative’s investments into tax-exempt municipals or growth stock that won’t provide current income. Try to keep the relative’s taxable income below the $3,300 level.

You do get a break if the relative receives Social Security benefits. Under a long-standing rule, the IRS does not include benefits in gross income for this purpose, although they do count toward the half-support test. (IRS Revenue Ruling 58-419)

Still another wrinkle: The tax benefits of dependency exemptions phase out for certain high-income taxpayers. For 2006, the phaseout begins at an adjusted gross income (AGI) of $188,150 for head-of-household filers, $225,750 for joint filers and $150,500 for single filers. That could affect the trade-off of the annual exemption.

Tip: If you receive no tax benefit from your support, waive any rights to the exemption. At least then, someone in the family will win!

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