Head of Household Filing Status

As I mentioned last time, the new rules for dependency (qualifying child and qualifying relative) have changed the rules for Head of Household filing status. It has to meet two qualifications.

Head of Household Qualification

1. The taxpayer must have paid over half the cost of maintenance of his/her house that served as the primary place of abode for over half the year for the taxpayer and a qualifying child or a qualifying relative.

2. The taxpayer must have been unmarried or legally separated**

** “legally separated” must be either
a) A decree of divorce
b) Separate maintenance on the last day of the year
c) Have lived apart from his/her spouse for the last 6 months of the year

Cost of Maintenance

Included:
* Real Estate Taxes
* Mortgage Interest (but not principal payments)
* Rent
* Utilities
* Upkeep and repairs
* Property Insurance
* Food consumed in the home
* Other ordinary home-maintenance expenses

Not included:
* Clothing
* Medical Expenses
* Education Expenses
* Life Insurance
* Transportation
* Food consumed off the premises
* The value of the taxpayer’s own services

Determining whether or not a taxpayer paid over half the cost of home maintenance is straightforward process: Add up the total of cost of maintenance paid by the taxpayer and others and determine whether he/she paid over 50%. If the taxpayer receives public assistance payments and he/she spends for home maintenance, the payments count as amount paid by someone other than the taxpayer.

Special Situations for qualifying relatives

1.Dependent Parents
If a taxpayer paid over half the cost of house maintenance for a parent who may be claimed as a dependent, the parent doesn’t have to meet the member of household test. In other word, the taxpayer qualifies as head of household even though his house is not the same as his/her parent’s.

(Smart tax tip)

Sometimes a single taxpayer can claim a parent as a dependent, but can’t claim the head of household filing status.

Why?The taxpayer may pay over half the parent’s total support. However he/she may not pay over half the cost of maintenance for parent’s house.

How to solve? Rearranging of financial assistance.
For example, if the parent currently pays his/her own rent and the taxpayer pays the parent’s medical bills, the taxpayer may qualify as head of household if they switch the payments for the next tax year. The parent will pay his/her own medical bills and the taxpayer will pay his/her parent’s rent.

2.Multiple Support Agreements

Usually qualifying relative has to meet the following requirements as I mentioned.

a)Relationship
b)No Q.C. of Another taxpayer
c)Support: Taxpayer provides more than 50% of the individual’s support.
d)Gross income < the exemption amount($3,200 for 2005)

However Multiple Support Agreements are one of exception for qualifying relative requirement that I didn’t mention.
Multiple Support Agreement may be made when no individual provided more than 50% of a person’s support, but two or more taxpayers together provided more than 50% of the person’s support. To qualify to participate in a multiple support agreement, a taxpayer must provide over 10% of total support for the other person. The qualified taxpayers may decide among themselves which will claim the person as the qualifying relative for dependency exemption.
Even if the person meets the support test for a qualifying relative because of a multiple support agreement, that person does not qualifying a taxpayer for head of household filing status.

3.Member of Household

Even if a person meets the member of household test for a qualifying relative because he/she lived in the household all year, the person does not qualify the taxpayer for head of household filing status. In other word, if the person is not related to the taxpayer, he/she can’t claim the head of household filing status. However, if non-family person meets qualifying relative requirements, the taxpayer still can claim dependency exemption and child care credit.

Claiming the child’s Exemption

A child may qualify a taxpayer as head of household even if the taxpayer released the child’s exemption to the non-custodial parent for the purposes of dependency and child tax credit.

Qualifying Child and Relative for Dependency Part 2

A Qualifying Child for Only One Taxpayer

The new rules required the definition of a qualifying child be applied once for all tax benefits. The result is a child cannot be claimed by multiple taxpayers for different benefits. If multiple taxpayers claim one child, it will trigger the tie-breaker rules (I will mention it later.).

Exception for Divorced or Separated Parents
The only exception to the rule is in the case of Divorced or Separated Parents. But it has to meet all of the following conditions if the exception rules apply.

1. One or both of the parents provided > 50% of the child’s total support for the year.
2. At the end of the year, the parents of the child are:
* Divorced or legally separated under a court decree of divorce or separate maintenance
* Separated under a written separation agreement, or
* Have lived apart for the last 6 months of the year, regardless of whether they were ever married.
3. The child lived with one or both parents for more than half the year.

For tax purposes, the parent with whom a child lived for the greater amount of time during the year is the custodial parent; the other parent is the noncustodial parent. Generally the custodial parent may claim the dependency exemption for that qualifying child. However the custodial parent may waive the child’s exemption for purpose of dependency and child tax credit to the noncustodial parent. In those cases, the noncustodial parent must have a signed Form 8332 for dependency and new Form 8901 for the child tax credit from the custodial parent.

Quick Reminder:
As I said in my last entry, new rules for a qualifying child reflect the following 5 tax benefits.

1. Dependency exemption
2. Head of Household filing status
3. Child tax credit
4. Earned income tax credit (EITC)
5. Child and dependent care credit

The exception rules apply the custodial parent can only release the dependency exemption and child tax credit to the noncustodial parent. The custodial parent is still able to claim the head of household filing status, EITC, and the child care credit if he/she would be eligible using the child as a qualifying child.

Qualifying Child of More Than One Taxpayer

Nowadays, there is no such thing as a typical American household. There are many family situations where a child may be a qualifying child of more than one taxpayer. (For this purpose, married taxpayers filing a joint return are treated as one taxpayer.)

Example: Maria and her son, Patrick, lived all year with Maria’s mother, Jennifer. Patrick is a qualifying child of both Maria and Jennifer. (See the qualifying child’s requirements in last entry.)

Who May Claim the Qualifying Child?
If a child is a qualifying child of more than one taxpayer such as the above example, the taxpayer may decide among themselves who will claim the child. The IRS generally will not get involved. However if more than one taxpayer actually claims the same child, the IRS will decide which claimant is awarded the child based on the tie-breaker rules.

Tie-breaker Rules

1. If only one of the claimants is the child’s parent, the parent will be awarded the child.
2. If more than one claimant is a parent of the child, the parent with whom the child lived for the greater amount of time during the year will be awarded the child.
3. If the child lived with each parent for the same amount of time during the year, the parent with the highest AGI will be awarded the child.
4. If none of the claimants is a parent of the child, the claimant with the highest AGI will be awarded the child.

In the above example, Maria will be awarded Patrick as a qualifying child because she is his mother if Maria and Jennifer claim Patrick.

Qualifying Child and Relative for Dependency

When I start writing about tax tip, I mentioned about Uniform Definition of a Child first. This was welcome news to many because the definition of a qualifying child previously varied depending on the tax benefit. This required a lot of work for tax professionals and caused confusion for taxpayers. However, the news is not good for some taxpayers who greatly impacted by the new definition.

The Working Families Tax Relief Act of 2004 includes a new uniform definition of a child (UDC). New Law redefines a qualifying child for the following 5 tax benefits.

1. Dependency exemption
2. Head of Household filing status
3. Child tax credit
4. Earned income tax credit (EITC)
5. Child and dependent care credit (I mentioned it in 01/10/2006.)

New law also creates a new tax term: Qualifying relative. The new definition of a qualifying relative applies to the following 3 tax benefits.

1. Dependency exemption
2. Head of Household filing status
3. Child and dependent care credit (I mentioned it in 01/10/2006.)

What is “qualifying child”? What is “qualifying relative’? Understanding of these terms is very important and the above tax benefits are based on them. So I explain about these terms this time.

Before we talk about qualifying child and qualifying relatives, there are 3 conditions that must be met for any individual to be claimed as a dependent.

1. Citizenship: Dependent must be either U.S. citizen or a resident of U.S., Canada, or Mexico.
2. Joint Return: Married dependent must not file a joint return.
3. Support: Dependent must not have provided > 50% of his/her own support.

Above 3 conditions are basic requirements. Now we look for each terms’ requirements.

Qualifying Child: must be met all requirements
1. Relationship:
The child must be either
*Son, Daughter, stepson, stepdaughter
*Brother, Sister, stepbrother, stepsister
*Adopted child
*Eligible foster child
*Descendant of any of the above
“Eligible” foster child means child was placed with taxpayer by authorized placement agency, by judgment, decree, by other order of any court of competent jurisdiction.

2. Residency:
The child must have lived with the taxpayer for more than half of year.
< Exceptions >
*Temporary absences: absences due to vacation, business, hospitalization, education, military services or short-term incarceration
*Kidnapped child
*Child who were born or who died during the year.

3. Age:
At the end of the year, the child must be either
*Under age 19
*Under age 24 and a full-time student full-time means at least 5 calendar months during tax year. Why 5 months? Usually school start from August. Since months from August to December count 5 months, that’s why it’s at least 5 months.
*Any age if permanent and totally disabled

Qualifying Relative: must be met all requirements

1. Relationship:
The person must be either:
*Father, Mother, Stepfather, Stepmother, Father-in-law, Mother-in-law
*Uncle, Aunt
*Brother, Sister, Stepbrother, Stepsister, Brother-in-law, Sister-in-law
*Son, Daughter, Stepson, Stepdaughter, Son-in-law, Daughter-in-law
*Eligible foster child
*Descendant of any of the above
*An individual who lived with the taxpayer the entire year
What does it mean? Is this ok for Boyfriend? Girlfriend? Or Cousin? Yeah! As long as person lived with the taxpayer all year.

2. Q.C. of Another Taxpayer
Cannot be a qualifying child of any taxpayer
For example, taxpayer lives with girlfriend and her son the entire year. Girlfriend may be a qualifying relative to taxpayer if all requirements met. However her son is not because he is qualifying child to his mom who is taxpayer’s girlfriend.

3. Support
Taxpayer provides more than half of individual’s support.

4. Gross Income
Gross income must be less than the exemption amount for that year ($3,200 for 2005)

Summary
Beginning with the 2005 tax year UDC is in place. 5 tax benefits are affected. I just mentioned about requirements for Qualifying Child and Qualifying Relative this time and I still need to mention about detail. I will write about detail next time. Right now, just remember about keywords.

Dependent requirements

3 basic conditions
1. U.S. Citizenship
2. No Joint return for married dependents
3. No > 50% of his/her own support

2 Types of Dependents: Qualifying Child and Qualifying Relative
Qualifying Child
1. Relationship: Blood, Step, Adopted, Foster
2. Residency: live > 6 months in home
3. Age: under 19, under 24 & Full-time student, Any age disabled
Qualifying Relative
1. Relationship: Blood, Step, Adopted, Foster, In-law, Uncle, Aunt, and Stranger who lived w/ you all year
2. Not be a Q.C. of another taxpayer
3. must be supported > 50%
4. Gross income < $3,200

Line 48 Credit for Child and Dependent Care Expenses

Single parents and two-career couples must find ways to care for their young children or a dependent while they work. If you are under this situation, you may be able to reduce your tax by claiming the Credit for Child and Dependent Care Expenses.

Requirements:
1. Married taxpayers generally must file a joint return.
2. The care must have been provided so the taxpayer could work or look for work.
3. The taxpayer must have some earned income.
4. The taxpayer and the person(s) for whom care was provided must have lived in the same home.
5. The payments for care cannot be paid to someone you can claim as your dependent or to your child who is under age 19.

Qualified Persons:
1. A dependent who is a qualifying child and has not reached his 13th birthday.
2. A dependent of any age who is physically or mentally incapable of self-care and lives in same place.
3. A spouse who is physically or mentally incapable of self-care and live in same place.

Qualified Expenses:
Included:
* Cost of services for the qualified person’s well-being and protection while the taxpayer works or looks for work
* In-home care of qualified person
- May also include amounts paid for cooking and light housework related to the care but not chauffeur or gardening services
- Household Employee Expense
Wages
Cost of meals and lodging furnished to the employee
Employer’s social security, Medicare, FUTA
Other Payroll Taxes paid on the wage

Taxpayer who pays wages of $1,400 or more during 2005 to household employee must pay employer’s share of social security and Medicare taxes.

Not included:
* Cost of clothing or entertainment
* Cost of transportation to and from the child care facility
* Overnight camp expenses
* Any expense allocable to the education of a child in the first grade or higher
(Exception) Total cost of schooling below the first grade qualifies only if cost of schooling and care can’t be separated.

Computing the Credit:
We need 2 steps to decide the credit amount.
1. To decide base amount. Base amount is the smallest of:
* Qualified expenses incurred and paid during 2005
* $3,000 for one qualifying individual or $6,000 for two or more qualifying individual
* The lesser of taxpayer’s or the spouse’s earned income
Be careful!!! For purposes of this credit, earned income also includes nontaxable earned income, such as
* Voluntary salary deferrals, such as those made to § 401(k) plans
* Meals and lodging provided for employer’s convenience
2. Base amount x % = Credit amount
% is based on your adjusted gross income.
The credit can range from 20% to 25% of your qualifying expenses, depending
upon your income.

Credit Limitation:
Credit for Child and Dependent Care Expenses is nonrefundable credit. The limit is up to his tax liability. Any excess is lost.

Employer-Provided Benefits:
If employer provides dependent care benefits that are shown in Box 10 of Taxpayer’s Form W-2, the benefits usually reduce the qualified expenses eligible for the credit.

Employer-Provided Benefits are usually non-taxable benefits. However, part of the employer-Provided benefits may be taxable if the benefits exceed the smallest of
* Qualified expenses
* The lesser of the taxpayer’s or the spouse’s earned income
* $5,000 ($2,500 MFS)
Any taxable amount should be added to the taxpayer’s wages entered on line 7, Form1040 or 1040A, the letters “DCB” written to the left of line 7. “DCB” means Dependent Care Benefits.

Standard Mileage Rate in 2006

After I send the information to my friends, I got a question about 2006 Standard Mileage Rate. Here is the information.

2006 Standard Mileage Rate

Business miles - 44.5¢ per mile
Charitable miles - 14¢ per mile (except Katrina-related charity)
Special Mileage Rates for Katrina-Related Charity
32¢ per mile as a charitable deduction
44.5¢ per mile for reimbursement purpose
Medical miles - 18¢ per mile
Moving miles - 18¢ per mile

Standard Mileage Rate in 2005

I think everybody knows and I don’t need to mention about standard mileage rate in 2005. But just in case, I mention about it.

In 2005, there are two separate rates depends on the date of travel.

1.January 1, 2005 ~ August 31, 2005
Business miles - 40.5¢ per mile
Charitable miles - 14¢ per mile
Medical miles - 15¢ per mile
Moving miles - 15¢ per mile

2.September 1, 2005 ~ December 31,2005
Business miles - 48.5¢ per mile
Charitable miles - 14¢ per mile
Medical miles - 22¢ per mile
Moving miles - 22¢ per mile

If you have Unreimbursed Employee Business Expenses (Form2106 or 2106EZ), use your own car for medical transportation (Schedule A-Itemized Deductions Medical and Dental Expenses) & for volunteer services to charitable organizations (Schedule A-Itemized Deductions Gifts to Charity), and move from the old to new home by car*(Form 3903) in 2005, please use these mileage rates.

* The taxpayer must meet 2 requirements: the distance requirement and the work time requirement.

Line 23 Educator expenses

Form 1040 Line 23 Educator expenses Deduction

An eligible educator may deduct up to $250 of qualified out-of-pocket expenses in Line 23. If married couple is filing jointly and both spouses are eligible educators, maximum deduction is $500. However each spouse is limited to $250.

Eligible Educator: 2 requirements

1. A kindergarten thru 12th grade - teacher, instructor, counselor, principal, teacher's aide

2. Work at least 900 hours during school year

Qualified expense: ordinary and necessary

Included: books, equipment, computer software, classroom supplies, other supplemental instructional materials and services used in the classroom

Not included: home schooling

Qualified expenses must be reduced;

1. Reimbursements received that not included in W-2
2. Excludible U.S Savings Bond interest from Form 8815
3. Nontaxable earnings from Coverdell ESAs and QTPs

Tax Tip:

If an eligible educator spends out-of-pocket expenses more than $250, he/she may deduct the balance more than $250 on Schedule A.