NEW YORK (CNNfn) - If you're at that stage in life where you're helping to support your parents, the financial and emotional stress can really add up.|
But if you do the math correctly, you might be entitled to a little tax relief.
You may, for instance, be able to take a dependency exemption of $2,800 this year for one of your parents, or at the very least deduct some of your mother's or father's medical expenses as your own.
Or, if your parents are not in need of daily support but are concerned about protecting their assets from the ravages of a costly health crisis or shrinking income in retirement, you might consider helping them pay for long-term care insurance or hiring them to work for you. Either action offers some tax breaks for you or your parents and potentially helps preserve your inheritance.
But as with most things tax-related, there are hurdles to overcome.
"There are always ifs, ands or buts," said Cindy Hockenberry, an enrolled agent and the spokeswoman for the National Association of Tax Practitioners.
Meet the income and support tests
In order for your parent, or indeed anyone, to qualify as your dependent, you both need to meet five "tests."
One is the support test. You need to show that you pay for at least half of your parent's support, regardless of whether he or she lives with you.
If you and your siblings together pay for at least half of your parent's support you must decide which one of you will claim the exemption in a given year and you must sign what's called a multiple support agreement, said New York-based certified public accountant Sidney Kess.
Keep in mind, the sibling who takes the exemption must provide no less than 10 percent of the parent's support. If, however, you alone provide more than half of a parent's support in addition to what your siblings provide, then you automatically get to take the exemption.
There is also an income test. Your parent must not have an annual gross income in excess of $2,800. That includes income from a pension or an IRA or taxable dividend income from investments. It does not include, among other things, Social Security payments, long-term care insurance benefits, gifts or tax-exempt income.
In addition, the person you wish to claim as a dependent must either be a member of your household or a relative, as well as a U.S. citizen or resident.
Finally, in most instances your parent may not file a joint return in the year you claim him or her as a dependent. The only time your parents may file jointly is "if they're doing so to get a refund and no tax liability would exist if they filed separately," Hockenberry said, explaining that in some instances they may have paid too much in estimated taxes or too much was withheld from their pension income.
Increase your chances of qualifying
All tests must be met in order for you to take advantage of the exemption. So if your mother meets the gross income test but uses her Social Security benefits to pay for more than half of her support, she won't qualify as your dependent.
That's why, where there is a fighting chance you might be able to take the exemption, tax experts like Hockenberry and Kess recommend that your parent deposit at least some of his or her excludable income such as Social Security into a bank account instead of spending it on support.
Skipping the audit
In most instances, claiming a parent as a dependent is not likely to raise a red flag at the Internal Revenue Service, experts say.
"It's hardly ever questioned," Hockenberry said.
That is, unless your parent claims a personal exemption on his or her tax return the same year you claim him or her as a dependent.
Similarly, you may be audited if your parent fails to file a return, but the IRS receives a number of W2s and 1099s in his or her name indicating taxable income greater than $2,800.
In any case, be sure to keep track of what you have paid for. "Record-keeping is important. Document everything you do," said Frank Degen, an enrolled agent and spokesman for the National Association of Enrolled Agents.
Those records include all cancelled checks for support and any receipts of expenses you paid on your parent's behalf.
Pricing yourself out of an exemption
If you are fortunate enough to make a large salary, you may not have the option of taking the dependency exemption, regardless of your parent's circumstance, Kess said
That's because the exemption begins to be reduced, or phased out, starting with single wage earners whose adjusted gross income in 2000 exceeds $128,950; and with married wage earners filing jointly whose AGI exceeds $193,400. If as a single filer, your AGI exceeds $251,450 - or if you're married, $315,900 - then you've priced yourself out of the benefit.
Get a medical deduction
Let's say you are paying for at least half your mother's support, but she doesn't qualify as a dependent because her gross income is too high.
You can still apply what you have paid for her medical care toward a medical deduction. But you will only qualify for that deduction if her medical bills combined with yours exceed 7.5 percent of your adjusted gross income in a given tax year.
As with any medical deduction, that's the rub, Degen said. "The seven-and-a-half percent rule is always a problem."
Helping your parents in other ways
Of course, for many people, their parents may be able to support themselves day to day, but they are no longer as flush with cash as they used to be. That means a health crisis can be devastating financially.
That's why Degen suggests that adult children who are well-off consider giving a parent a tax-free gift of up to $10,000 every year to pay the premiums on a long-term care insurance policy.
"That's a winner all the way around," Degen said, noting that parents will get the money to pay for a policy and will be able to take a tax deduction for the payments. Their children benefit because that policy helps protect the money in their parents' estate.
"You're protecting your inheritance," he said.
If your parents want to make a modest income in their later years, you also can hire them to provide domestic help. If you do, you're not liable to pay Social Security or Medicare tax on their behalf, so long as they're providing legitimate service.
But be careful. "It can't be like a babysitting situation." Degen said, explaining that if the IRS suspects you are hiring your parent for nanny duty, it will expect you to fork over the taxes.
At least it will expect some people to fork over the taxes. The law governing who is and is not excused from paying FICA and Medicare tax is not necessarily even-handed.
According to the law, if you're widowed or divorced or have a spouse that is mentally or physically disabled, and you have a child living with you who is under 18 or disabled, then you would have to pay your parent's FICA and Medicare, just as you would a nanny's.
You might qualify for the exemption, however, if you are part of a two-career couple with kids or a single parent who has never married, Degen said. But, he added, check with a tax adviser first.
Know thyself and the rules
Whatever option you and your family choose, be sure to educate yourself about the details, especially if you do your own taxes.
"There are technical rules that you have to be careful about understanding," said Kess, who recommends at the very least reading a tax book for guidelines on how to take a dependency exemption and medical deduction.
But most important, Hockenberry said, be clear about your situation before taking action. "Have a good financial picture of yourself and your parents."