Exemptions and the Dependency Test

In computing how much of your income is actually subject to federal income tax, you're automatically entitled to subtract two amounts: a personal exemption, and a standard deduction. The sum of these amounts is not taxed, period. Of course, you can choose to itemize your deductions rather than claiming the standard deduction, if itemizing would result in a lower tax bill. The remainder of this section explains personal exemptions and how to determine whether a particular person is your dependent or not.

The rule is that one (and only one) personal exemption is available for every individual - adult or child. The amount of the exemption is $3,900 for 2013 ($3,950 for 2014). This amount is indexed for inflation every year.

Starting in 2013, higher-income taxpayers could have their personal exemption amounts reduced—possibly down to $0. The phaseout begins at these levels:

• $300,000 for married couples filing jointly and surviving spouses
• $275,000 for heads of households
• $250,000 for unmarried taxpayers
• $150,000 for married taxpayers, filing separately

(The inflation-adjusted threshold amounts for 2014 are $254,200 for unmarried taxpayers, $305,050 for married filing jointly and surviving spouses; $279,650 for heads of households; and $152,525 for married filing separately.)

Under the phase-out, the total amount (combined personal and dependent exemptions) will be reduced by two percent for each $2,500 (or any portion of $2,500) that your adjusted gross income exceeds the applicable threshold. If you are married, but file a separate return, $1,250 is substituted for $2,500 in determining the phaseout.

On a joint return, you could automatically claim one exemption for yourself and one for your spouse, for a total of $7,800. You can claim an exemption for your spouse even if he or she died during the year, provided you have not remarried. (If you are married filing separately, you can claim your spouse's exemption on your own return only if your spouse had absolutely no gross income for the year and was not the dependent of any other individual.)

Besides the personal and spousal exemptions, you should also claim an exemption for each of your dependents. The catch is that if you can claim a dependency exemption for an individual, that person may not claim a personal exemption on his or her tax return.

Warning There is nothing optional about this rule. If you are eligible to claim, say, an exemption for your child who is away at college, you cannot choose to let the child claim his or her own exemption even if you want to. One possible way around this rule is to make a hefty gift to the child in one year, and then refrain from paying more than half of the child's support in later years. The child could use the gift money to support himself or herself and could then claim the personal exemption on his or her own return.

Dependency exemptions have their own set of rules, including:

• how to claim them on your tax form
• which individuals qualify as your dependents