Tax exemptions are the good deductions you get for yourself, your spouse and your kids. Actually you can claim tax exemptions for basically any relative that you support. You can claim the tax exemptions for them even if they don’t live with you.
At maximum you can only get about a $4,000 deduction for each of the tax exemptions you claim in a year. The exemption amount usually increases a little each year, so check IRS.gov and see what it is for the year you are interested in. This deduction isn’t a “standard deduction.” It lowers your adjusted gross income, which is a big deal.
Adjusted gross income is the magic tax number. It determines whether you get to contribute to a Roth, what tax exemptions you can take advantage of, what your tax rate is, and dozens of other tax issues (health care subsidies, anyone?). Your tax planning needs to concentrate on lowering your adjusted gross income, not just on deductions. Your adjusted gross income is hard to lower if you are a simple W2 employee. The personal and other tax exemptions you can take advantage of are one of the few adjusted gross income tools you have available.
Tax exemptions are nice, but they may not really help much. If you’ve got a $300,000 adjusted gross income then you would have to have a lot of kids to claim as tax exemptions if you want to make a real dent in your tax bill. In fact, if you’ve got a $300,000 adjusted gross income, all of your tax exemptions would phase out anyway, aka, you get no help from the tax exemptions – you lose.
Take All the Tax Exemptions You Can Get to Cut Your Adjusted Gross Income
Of course, you will take yourself and your spouse as tax exemptions. Then take tax exemptions for any “dependents” you have. Children are the primary source of additional tax exemptions. I have actually found several websites about adjusted gross income that say you should adopt kids to lower your adjusted gross income. (They have obviously never raised a child–that is no way to save money.) There are easier ways; just let me give you some tips.
In order to get a tax exemption, the child has to live with you more than half the year if they are under 19 years old, or they can be a full-time student under age 24. The child can’t provide for more than half of their own support. You used to have to prove that you paid more than half their support, but that’s not necessary any more.
Other relatives can qualify as your dependents and you can get tax exemptions for them. You’ll get the deduction for any “qualified person.” Note that if a child doesn’t qualify as under 19 or a 24 year old student, they may qualify as an “other relative.” In order to qualify, the “relative” must:
- Be a relative under the definition of “relative” or be a full-time occupant of your home
- Be a US citizen or resident of Mexico or Canada
- Not file a joint income tax return with anyone
- Receive over half their support from you
- Have a gross income that is less than the legal deduction
All this raises the issue of who is a “relative”?
According to the IRS, relatives are by blood or marriage. The following people qualify as “relatives” for tax exemptions.
- Children or Stepchildren
- Your Brothers and Sisters (Including half or step siblings)
- Parents, Stepparents or other direct ancestors such as grandparents
- Uncles and Aunts
- Nephews and Nieces
Tax Exemptions Phase Out Based on Adjusted Gross Income
Tax exemptions are actually phased out by the alternative minimum tax. The alternative minimum tax is a parallel tax system that is intended to make sure the rich “pay their fair share.”
The problem is the alternative minimum tax law that was originally designed to hit the rich is now squarely cutting the middle class down. The alternative minimum is adjusted each year, but the tax kicks in at an astoundingly low $80,800 for a married couple. The exemption for alternative minimum tax a few years ago was a whopping $50,000 for married couples filing jointly and $38,750 for singles.
That means the alternative minimum tax kicks in at $50,000 and you start losing your tax exemptions, because the alternative minimum tax just wipes them out. Did you think you were rich and should be paying your fair share at $50,000?
Any law that is passed to “get the rich” will end up killing the middle class, because the middle class is where the money is. Collectively the wealth of the middle class dwarfs the wealth of the super rich.
Take advantage of every one of the tax exemptions you can get.
Tax Exemptions of another kind that lower YOUR Adjusted Gross Income
Although deductions like medical deductions are not really tax exemptions, many people refer to those types of deductions as tax exemptions.
The trick is to get the deductions that will affect your adjusted gross income. Make sure you check out our Tax Tips that will actually make a dent in your adjusted gross income (AGI).
Your AGI is where you need to concentrate on lowering taxes. The best way to do this is to start a little business. You’ve got to use the “legal tools” such as to LLCs, corporations, and limited partnerships to really attack and lower your adjusted gross income.
These legal tools have different tax laws applied to them than you have applied to you as an individual. What they do flows down to you, but all of their deductions come out before your adjusted gross income is calculated. So they can make a good sized dent in your adjusted gross income, if you know how to use them.
You’re going to have to make the connection between your company and your 1040 tax form.
If you do have a company of some sort, learn how to use it as a tax shelter. This will give you thousands of extra dollars to spend each year. You won’t work any harder or have to make funny, risky investments; you will just be using the law to take care of your hard earned money.
If you don’t have a company yet, may I suggest there may be lots of reasons to have a company that you’ve never thought of. How about a company to plan your family reunions? Once you have the company structure you can make progress on lowering your adjusted gross income.
But if you don’t have a company and can’t see how to get one, you should still take advantage of the tax exemptions available to you. Let’s put your adjusted gross income on a diet.