Claiming a child as a dependent

Special to's tax-advice column features three experts from the Hunt Valley accounting firm SC&H Group answering questions about preparing your return every Monday until April 17. To be included in the following weeks, please use the form at the right side of this page to submit your questions.

Janet Gainey, Baltimore: My husband is collecting retirement from SSA and support for our two minor children from SSA ($386 each). IRS informed us that a portion of my husband's retirement is taxable after filling out the form in the book and that none of the support for our children is taxable. My oldest daughter started working for the first time in 2005.

After researching, I found that my daughter's income does not have to be claimed if she doesn't exceed $4,500, approximately. However, the confusion comes as to whether she is still our deduction, or can she file on her own, and if so, we can't claim her. She still lives under our roof. Since my husband receives a check from SSA for her benefit, wouldn't that compel us to claim her and all her wages?

SC&H Group: Your oldest daughter will be considered a qualifying child for you to claim as a dependent if she meets all of the following conditions:

  • She is under age 19 at the end of 2005; under age 24 if she is a student; or any age and permanently or totally disabled.
  • She did not provide over half of her own support for 2005.
  • She lived with you for more than half of the year. If she meets the criteria above, you can claim her as a dependent on your tax return. Your daughter's income is below the filing limit, so she is not required to file her own return. She may, however, wish to file to claim a refund for taxes withheld. She must mark a box on her return that indicates she can be claimed as a dependent on someone else's return. Karl Whitehurst, Maryland: My daughter is 17 and worked in 2005 part time. She wasn't in school because she quit. She received a W-2. Does she need to file taxes? SC&H Group: If your daughter's earned income is more than $5,000, she is required to file a federal income tax return. If her income was below the $5,000 threshold, she may wish to file a return to claim a refund of taxes withheld from her pay. Jackie H., Pasadena: We bought a new motor home this year. I understand that we can deduct the sales tax on our taxes in 2007. How does that work? SC&H Group: For 2005, taxpayers who choose to itemize deductions can elect to deduct state and local general sales tax in lieu of state and local income taxes. The provision that allows this deduction expires at the end of 2005. No sales tax deduction will be allowed after 2005 unless Congress extends the provision. Refer to the sales tax tables in the Form 1040 booklet and add any amounts of sales tax paid on motor vehicles, boats and other items. Then, choose the tax deduction producing the larger benefit. A motor home purchase may qualify as a second residence for you. To qualify, the motor home must have sleeping, cooking and bathroom facilities. If it qualifies as a second residence and you financed the purchase, the interest on the loan is deductible on Schedule A as mortgage interest. J. Smith, Baltimore: I have not received my 1099 retirement form from Baltimore City. How long do I have to wait [before requesting that the city send it]? SC&H Group: All Form 1099s are required to be postmarked no later than Jan. 31. If you have not received your 1099, you should call now to follow up with the issuer. Patrick Flynn, Baltimore: My mother has a number of medical expenses that total over $25,000 for this year. Most of this is for what we pay people to come in and help her with basic needs such as bed, bath, feeding, etc. My mother is bedridden as the result of a stroke and can't do these things for herself. We pay people out of our pocket and do not withhold any taxes. Can we claim this expense without causing any tax problems for us or the people who help my mother? SC&H Group: Yes, you are permitted to deduct any medical expenses that exceed 7.5 percent of your adjusted gross income, even if they are paid on behalf of a dependent. This deduction is taken on Schedule A of your personal income tax return if you itemize your deductions. You should retain copies of all documentation regarding payment of these services for proof in case of an audit. [On] your question regarding "tax problems" for the caregivers, the IRS could be alerted to this if you are ever audited and they request proof of your deductions. They would then pursue the caretaker to see if the fees that you paid to them were reported on the caretaker's tax return. Taxpayers who hire individuals to work in their homes should review the rules related to household employees and the reporting and withholding requirements therein. John, Sykesville: A friend of mine needed money for a down payment to buy a house so she could move her very ill mother and father in and be able to take care of them. She took $15,000 out of her 401(k). She got a tax bill for about $500. Is there any provision in this case that the tax would waived, due to serious and unusual necessity? SC&H Group: It appears that your friend's situation qualified her to remove funds from her 401(k) in accordance with the "Employee Hardship Distribution." A hardship distribution is one that is made because the individual is in immediate and heavy financial need. Expenses that satisfy this requirement are:
  • medical expenses of the individual, spouse and dependents;
  • expenditures to purchase a principal residence (this excludes actual mortgage payments, but allows for a down payment);
  • post-secondary tuition for the individual, spouse or dependents;
  • and expenditures for stay eviction or foreclosure of the individual's principal residence. An early distribution from an individual's 401(k) triggers income tax on the amount distributed, as well as a penalty of 10 percent on early withdrawal. The income tax is unavoidable in any circumstance, as the money that was deposited to the account was pre-tax dollars. There are exceptions to the 10 percent penalty rule, but it sounds like the only exception that may apply to this case is if your friend was over the age of 59 1/2 when she took the distribution. She must report the entire distribution as income on her return, as well as pay the 10 percent early withdrawal penalty. She will receive a Form 1099-R from the plan administrator that reports the distribution to the IRS and a copy of this form must be attached to her return. A reader, Columbia: Can you write off the closing cost on the purchase of a home? If so, where does it come under? Thanks! SC&H Group: You may deduct certain costs associated with the purchase of your home on Schedule A, if you itemize your deductions. These include such costs as loan discount fees and points paid, or "loan origination fees," as they are normally referred to on the settlement sheet. Any property taxes paid at [the] time of settlement may also be deducted. All other expenses would be capitalized and included in the purchase price of your home. Deborah Lee, Baltimore: My mother passed away in January. She was 89. Is there anything that I need to do concerning her taxes? SC&H Group: You will need to file your mother's 2005 individual income tax return by April 15 if she has sufficient income. Since she passed away in January, you may need to file a 2006 individual income tax return, depending again on her income situation. Another aspect to consider is the issue of whether or not your mother has an estate that needs to be administered, which would include the process of probate and possibly the filing of federal and Maryland estate tax returns. John, Frederick: How do I claim the one-time tax credit for a long-term health care premium on our Maryland tax returns? Eileen Ambrose, in her personal finance column on long-term health care in the Jan. 29, 2006, Sun, stated: "Maryland, for instance, gives residents 41 and older a one-time tax credit equal to the premium paid or $500, whichever is less." I'd like to know how I'd claim this tax credit on our Maryland tax return. SC&H Group: The credit is claimed using Form 502CR -- Personal Income Tax Credits for Individuals. Complete Section E. The form can be found here. Once you calculate the credit amount, you report that amount on Line 27 of Form 502 -- Maryland Tax Return (Resident Individual). Make sure to include Form 502CR when filing your Individual Maryland Return. Also, please note that the amount of the credit is further limited to $270 for individuals who are below age 41. Lois West, Ellicott City: I was divorced in 2003. According to my divorce degree, my ex-[husband] was to provide alimony to me, but not claim it on his taxes. He has recently decided that was illegal, so has since claimed all backdated alimony. Obviously, I did not pay taxes on this money. What are my options? SC&H Group: Alimony is deductible from income in the year paid by the payer spouse, and includable in income by the payee spouse. However, if the divorce decree designates these payments as "not alimony," then they are not deductible by the payer or includable by the recipient. If the divorce decree specifically states that the amounts are not deductible or includable as alimony payments, then he should not be deducting them and you should not be including them. If it turns out that your decree states the payments are alimony, and is silent on the taxability of them, then you may have to amend prior returns to report the income. If your ex-husband is amending returns and taking the deduction, you will have to go back and amend prior returns to include that amount. Unfortunately, you will also need to pay tax on that additional amount. To the extent that you take a position on your tax return that is inconsistent with the treatment on your ex-husband's return, you should be prepared to defend your position. We recommend that you consult a qualified tax professional to review your position before proceeding to report inconsistently. Lisa, Baltimore: My daughter and granddaughter have lived with me for most of the year. My daughter has found out about a tax reimbursement if you make under $38,000. She earned way under this amount. I want to know that if I claim head of household, can she still collect that reimbursement, or would she have to file her taxes on her own? My income for the year of 2005 is approximately $38,500. She was told that she would not be able to collect if I am the head of household because I earn too much money for her to receive that benefit. Was she given the correct information? SC&H Group: We believe your daughter is talking about the Earned Income Credit (EIC). The EIC is claimed by completing Schedule EIC to Form 1040 or 1040A, or directly on Form 1040EZ. Based on your question, we assume that your daughter is not married. Your daughter would need to file her own return and not be claimed herself as a dependent on your return to qualify for the EIC. It also sounds like you are receiving correct information on the issues surrounding actually being able to receive the EIC. However, the reason she would not be able to collect the EIC is because she is claimed as a dependent on your return, not because you make too much money. Your earnings do appear to exceed the limit to claim the EIC for yourself. You may want to look at the pros and cons of having your daughter file her own return (as a nondependent) and claim the EIC versus you claiming her (and her daughter) as dependents. You will need to determine whether your daughter is eligible to claim her own dependency exemption for this purpose. There are also other credits such as the Child Tax Credit, Additional Child Tax Credit and the Child Care and Dependent Care Credit that you may want to look into and see if they apply to you (or your daughter). Debbie, Pasadena: [I] sold my three-year-old house in November 2005. [I] received a statement from the mortgage company that only listed half of the Baltimore County property taxes were paid in July 2005. However, I'm sure I was paying taxes for the other five months of the year and that bill would have hit in December 2005. How do I calculate the amount of property taxes I paid for the entire year? Also, on the settlement sheets of the new house, I had to pre-pay five months into 2006. SC&H Group: The payment of real estate taxes on the new house is deductible in the year paid. When you sold the house in November 2005, the liability for the December property tax payment was transferred to the new owner. It sounds like you were making payments into an escrow account for property taxes between July and November. These payments are not deductible. When you sold the house in November, you should have received a refund of the unused balance. In your situation, to calculate the deduction for real estate taxes paid, you will need to add the following amounts:
  • the payment made in July 2005 on the old house;
  • any adjustments for real estate taxes reported on lines 510, 511 or 512 of the settlement sheet for the sale of your old home;
  • any adjustments for real estate taxes reported on lines 106, 107 or 108 of the settlement sheet for the purchase of your new home. From this total, you will need to subtract the following amounts:
  • any adjustments for real estate taxes reported on lines 406, 407 or 408 of the settlement sheet for the sale of your old home;
  • any adjustments for real estate taxes reported on lines 210, 211 or 212 of the settlement sheet for the purchase of your new home. Hank, Baltimore: I received a lump-sum settlement as part of a class-action lawsuit against a former mortgage company. How do I determine if the settlement I received is taxable? SC&H Group: As a general rule, an award or settlement is taxable if it replaces taxable income. Depending on your situation, you may be able to reduce the taxable amount if you had an original investment amount. If the settlement represents a return of capital, you may be able to reduce the proceeds up to your original investment amount, therefore reducing your taxable amount. However, if the settlement agreement characterizes part of the payment as punitive damages, that portion will be taxable as ordinary income. Brian Sipe, Baltimore: My wife and I purchased our first home together in 2005 and will be itemizing for the first time. What, if any, of the fees and taxes paid at settlement can we deduct? SC&H Group: The expenses related to settlement that can be itemized are points, interest and real estate taxes. Don't forget to count seller-paid points. Points are often referred to as loan origination fees or loan discount fees and are computed as a percentage of the loan amount and are treated as prepaid interest. Other costs associated with settlement, including attorney's fees, abstract fees, charges for installing utility service, inspection fees, transfer taxes, stamp fees, survey fees and owner's title insurance are not deductible. These costs are added to the residence basis. Be careful not to deduct deposits into your escrow account, until they are withdrawn to pay real estate tax invoices. Lisa, Baltimore: I would like to take money out of my IRA retirement fund for the purchase of a first home. I have read the IRS policy on such a matter and know that I can do this. However, do I have to repay the amount taken out of the IRA? Do I pay tax on this amount? SC&H Group: Yes, you are able to withdraw from your IRA fund to purchase your first house, but certain conditions have to be met in order to avoid the 10 percent early distribution penalty tax. The total lifetime amount permitted is $10,000; any amount [more than that] is subject to penalty. Also, the distribution must be used within 120 days to pay for qualified expenses, which include acquisition costs, settlement charges and closing costs. Income tax would be due on the distribution; therefore, the funds do not need to be re-deposited into the account. R. Vordemberge, Timonium: I have to take [a required minimum distribution] this year. Can I fulfill this obligation by withdrawing from my nondeductible IRA? Thank you for your answer. SC&H Group: No, IRA distribution rules do not allow the owner to take out nondeductible amounts first when taking a required minimum distribution (RMD). The reason is, when calculating the RMD -- which is based on a life expectancy factor found in the Uniform Lifetime Table -- all of the individual's IRAs are aggregated for purposes of allocating basis to distributions. Any distribution is deemed to come proportionately from the non-taxable and taxable portions of the aggregated IRAs. Margaret, Baltimore: I own a condominium. We recently made major renovations to the building. Can I deduct the cost of these off my taxes? SC&H Group: No, you cannot deduct the costs of major renovations from your current taxes. Instead, costs associated with the improvements are added to the condominium's basis, which can offset a potential gain in the future. Special tax assessments to the building that are paid by individual condominium owners may be deductible. If the condo is a rental, then the answer changes, as improvements to the unit would create additional depreciation deductions.
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