Claiming Dependents on Your Tax Return
Filing business taxes and individual taxes can become complex with so many tax rules, credits, deductions, and other details involved.
An essential detail to understand when filing taxes is knowing when and who you can claim as a dependent. While you must be careful to follow all relevant tax laws, dependents are a great way to reduce your tax obligation.
In this article, we’ll examine which individuals in your household qualify as a dependent under IRS rules, the advantages of claiming dependents on your tax return, and other applicable factors related to claiming dependents for tax purposes.
We’ll also take a look at why you want to consider applying for an employer identification number (EIN) for your business sooner rather than later.
Let’s jump into the specifics regarding dependents and how to claim them on your tax return.
What is a Dependent?
The IRS defines a dependent as a child or other qualifying relative who lives in your home and is financially supported by you. You cannot claim yourself or your spouse as a dependent on your tax return. The IRS applies the following rules to claiming dependents.
● Dependents can’t claim anyone else as a dependent on their own tax return
● Dependent must possess a valid Social Security number or other qualifying taxpayer ID number
● Dependent must be one of the following:
○ U.S. citizen
○ Resident alien
○ National
○ A resident of Canada or Mexico
● Individuals can only be claimed as dependents on one tax return per year (some parents alternate years if they both support their children or the parent who the child lived with most of the time claims them)
● Dependents must receive more than half their monetary support from the individual who is claiming them on their tax return
Generally speaking, to claim a dependent, the individual must have resided in your home for more than half of the tax year.
Benefits of Claiming Dependents on a Tax Return
Taxpayers who are eligible to claim qualifying dependents on their tax returns get several financial advantages. These benefits range from overall cost savings to specific tax deductions, credits, and other benefits.
Frequently claimed dependent tax credits
IRS code allows for numerous tax credits, but when it comes to claiming dependents, there are several common credits allowed by law. These include the Child Tax Credit, Adoption Tax Credit, Child and Dependent Care Credit, Earned Income Tax Credit, and American Opportunity Tax Credit. If a dependent qualifies for one or more of these credits, this can reduce how much tax you owe on a dollar-for-dollar basis. In some cases, this significantly reduces your tax obligation and when coupled with other tax credits, you can substantially reduce your tax bill.
Common tax deductions
Tax deductions are slightly different from tax credits, but their usefulness is the fact they reduce total taxable income. This means you’ll owe fewer tax dollars. If you have qualifying dependent(s), you can claim their medical expenses, dental expenses, student loan interest, and other eligible educational expenses. Pair this with all other non-dependent related eligible deductions and credits that offer families tax breaks, and you can owe less money to the IRS.
Head of household status
This isn’t a deduction or credit, but if you qualify, you can owe less in taxes to the federal government when tax time comes around.
To claim head of household, you must have a qualifying dependent, have been unmarried on the last day of the tax year you’re filing for, and pay for more than half the cost of maintaining your household during the tax year.
The IRS does have one exception. If you support a parent you can claim as a dependent, they do not have to live in your home for you to be eligible to claim head of household status.
Important Things to Know About Dependents
Individuals eligible to be claimed as dependents include child(ren), stepchild(ren), siblings, half-siblings, and parents. Domestic partners can occasionally be eligible to be claimed as dependents if they can’t support themselves.
Eligibility rules are as follows:
● Children under the age of 19 or, if older, up to 24 if a full-time student
● Individuals who are permanently and totally disabled can be of any age
● Rules may differ, depending on specific situations
The IRS uses qualifying factors for all types of dependents.
How qualifying children are determined by the IRS
The IRS sets five tests to help taxpayers determine whether they have a qualifying child.
Relationship test: The child you’re claiming must be your child, stepchild, foster child, sibling, or step-sibling (or a descendant of these family members).
Residency test: Your dependent must share your primary residence with you for at least six months of the tax year you plan to claim them. (Some exceptions may apply; check with the IRS or a tax professional to see if you meet the qualifications).
Age test: Your dependent must be a) under 19 years old at the end of the tax year, b) a full-time student age 24 or younger, and c) any age if your family member has a permanent or total disability.
Support test: You must spend more than half of the money used to support your dependent (e.g., if they are paying for 60% of their own support, they would not qualify).
Joint return: The dependent cannot file a joint return for the tax year they are being claimed as a dependent. The IRS does allow for it under the circumstances that the dependent is only filing, so they can claim estimated taxes they already paid or claim a refund of income tax withheld.
Determining if you have a qualifying relative (not your child)
The IRS has four tests to help taxpayers determine if they have family members whom they can claim as dependents on their tax returns.
Not a qualifying child test: If the dependent is listed on another taxpayer’s return as their qualifying child, you cannot claim them.
Support test: You must provide more than half of the support for the adult dependent you’re claiming on your tax return.
Member of household/relationship test: The dependent must reside in your home all year as a household member. Qualifying adult relatives include parents, stepparents, grandparents, and other direct ancestors (uncles, aunts, nephews, nieces, and in-laws (parents, siblings). Foster parents do not qualify to pass this IRS test.
Gross income test: You cannot claim a family member as a dependent if they make more than $5,500 (current amount for 2024, but this will change year-to-year). An exception is if your dependent has a disability and earns wages from a sheltered workshop. In this case, income would be excluded.
Apply for EIN for Business Taxes
Corporations file their own tax returns, but most small business owners typically file their individual and business tax returns together. Any business owner who hires employees must have an employer identification number (EIN). However, even those who don’t need an EIN find having one to be advantageous.
Benefits of having an EIN
Aside from gaining the ability to legally hire employees, benefits include the ability to open a business bank account, gain access to favorable business loan terms, apply for specific permits and licenses, and simplify the tax filing process.
How to obtain an EIN
You need to include your SSN when filing your individual tax return, but you can use your EIN for the business portion of your tax return. To obtain an EIN, you’ll need to do the following.
● Assemble required information, including your company’s legal name, date the business was opened or acquired, business address, phone number, business entity structure (e.g., sole proprietorship or LLC), and DBA designation (“doing business as”) if applicable.
● Include the name of the person responsible for the business and their taxpayer ID (either an SSN or an ITIN).
● Select the reason why you need to obtain an EIN.
● List the number of employees you currently have working or an approximation of how many you plan to hire).
● Proofread your application, ensure all questions are answered, and check for accuracy.
● Submit your EIN application and wait to receive your number.
Once you obtain an EIN, you’ll quickly see the advantages you’ll gain because, even if you don’t need it now, you’ll be prepared for the future if you need to take out a business loan, hire employees, or open a business bank account. This way, you avoid delays that could negatively impact your operations.
Conclusion
The ability to claim dependents on a tax return can significantly reduce the amount of taxes you owe, which means you have more money to invest in your company or use for other purposes. However, you want to be accurate and ensure your dependents meet the IRS eligibility rules. If you claim a dependent who you shouldn’t claim, you could face severe consequences, including but not limited to expensive fines and penalties. You also could trigger an audit, which opens up another host of problems.
Understanding tax rules regarding dependents can be confusing. To simplify the process, you may want to consider working with an accountant, tax attorney, or other tax professional.