With people living longer and longer, the prospect of outliving ones financial resources looms larger and larger.
The original concept of Social Security being a safety net to prevent destitution has long been obliterated. Unfortunately, the elderly have grown to believe that if one can simply make it to 65, Social Security benefits will provide adequate retirement benefits until death.
In most cases, this just isn’t true.
When folks reach retirement age with nothing but Social Security to rely on, one of several distasteful choices must be made: (1) assume a more modest lifestyle, (2) continue working, or (3) look to family members for additional financial support.
In those cases where the latter option is chosen, there is a small measure of relief available to the supporting family member if the elder person qualifies as a dependent. As with all tax issues, the rules are complex.
There are five tests – hurdles to be leaped – before one can claim a dependency exemption for an older family member.
– Gross income test.
The dependent’s gross income cannot exceed the personal exemption, which is $2,800 for 2000. That amount is likely to rise to $2,900 for 2001. Since Social Security benefits are not generally taxable income, they are not considered for this test.
– Support test.
To claim a dependency exemption, you must provide over half of the dependent’s support. “Support” includes food, shelter, clothing, medical and dental care, etc. Unlike the gross income test, Social Security benefits received by the dependent and used for his support is a factor in this test. If more than one family member shares in supporting a parent or other elderly dependent, a multiple support agreement (MSA) can be used to divide the exemption among the supporters. Here’s the deal. If no one person provides more than 50% of the dependent’s support, but the group does provide more than 50% support, the group can decide who gets the exemption. The person claiming the exemption must have contributed at least 10% of the total support. Supporters can alternate who claims the exemption from year to year as long as the 10% test is satisfied.
– Relationship test.
The dependent must either be related to the taxpayer or live with the taxpayer for the entire year. The definition of who qualifies as related to the taxpayer is fairly broad. There is no requirement that a person satisfying the relationship test must live with the taxpayer. If the supported person is not related to the taxpayer, they must live with the taxpayer.
– Citizen/resident test.
The dependent must be either a citizen or resident of the United States, or a resident of Canada or Mexico.
– Joint return test.
The dependent must not file a joint tax return unless it is filed solely to claim a refund.
Qualifying a parent or other family member as a dependent opens the door for tax deductions beyond the dependency exemption.
In addition to claiming a tax deduction for a dependency exemption, medical expenses paid for a dependent are deductible by the supporter if paid by him. Medical expenses include doctors, hospitals, nursing care services, hearing aids and batteries, oxygen and wheelchair rental. The deduction for medical expenses for both the taxpayer and dependents is limited by a percentage-of -income adjustment, which severely limits the actual deduction for medical expenses.
Another possibility for tax relief is the dependent care credit.
Although this credit is typically used for childcare expenses, it is also available to a taxpayer who maintains a household and must hire someone to care for a dependent “who is physically or mentally incapable of caring” for himself or herself. This definition includes required assistance with nutritional needs or personal hygiene and may involve full-time care for the safety of the dependent or society.
If all the dependency tests are met except the gross income test, a little creative financial rearranging could solve the problem. Consult an expert before you attempt to remedy the situation on your own.
No sane person would undertake to financially support a family member solely to obtain tax benefits. However, if support is required for other reasons, qualifying for tax relief can lighten the load somewhat.
Thought for the Moment
Invent not a lie, to get profit thereby.
– English saying
Joe D. Jones, CPA, is publisher of the Mississippi Business Journal. Contact him at firstname.lastname@example.org.