Tax Breaks for Helping Out Relatives (Part 2)

These days, the odds of having a relative who is struggling with debt or out of work are unfortunately pretty high. But if you can afford to help one of those relatives out financially, you may be entitled to some tax breaks that help you out.

Here's the second of a two-part series on how you can extend some generosity to family members and get a little something back from Uncle Sam for doing so. (See the first part of this series here.)

As you probably know, you can only claim an itemized medical expense deduction to the extent your total health-care expenses for the year exceed 7.5% of adjusted gross income (AGI). (AGI is the number on the last line of page 1 of your Form 1040.) If your expenses don’t exceed that threshold, you get no write-off. While clearing the 7.5%-of-AGI hurdle is usually difficult, it can be easier when you also pay the medical expenses for a qualifying relative because you can add that amount to your own expenses.

Does your relative qualify?

For a person to qualify as a relative for medical expense deduction purposes, all the following requirements must be met.

Support Requirement: You must provide over half the person’s support for the year.

Relationship Requirement: The supported person must be your child including a stepchild, adopted child, or descendant of your child (typically a grandchild); or your brother, stepbrother, half-brother, sister, stepsister, half-sister, or a descendent of one of these individuals (typically a niece or nephew); or your son-in-law, daughter-in-law, father, stepfather, father-in-law, mother, stepmother, mother-in-law, brother-in-law, sister-in-law, aunt, or uncle.

Citizen or Resident Requirement: The supported person must be a U.S. citizen, a U.S. resident alien, a U.S. national, or a resident of Canada or Mexico.

Same Household Requirement for Person Who Fails Relationship Requirement: If the supported person doesn’t meet the relationship requirement, he or she is still considered to be your qualifying relative if you live in the same household and the other tests listed earlier are passed. For example, a supported godchild could fit into this category even though he or she is not a blood relative or in-law.

Adding It All Up

Once you’ve established that you have a qualifying relative, add up all your medical expenses plus those you pay for the relative. If the total expenses exceed 7.5% of your AGI, you can claim your rightful itemized deduction on Schedule A of Form 1040. But don’t get carried away. You’re only allowed to count a relative’s expenses when you pay them directly to the medical services or health insurance provider. Simply subsidizing amounts paid by your relative won’t do the trick.

A common (and expensive) error committed by many unmarried individuals is filing as a single taxpayer when you could file as a head of household (HOH). In these tough economic times, head of household status may be available to you for the first time if you're now supporting a struggling parent or out-of-work relative. Filing as head of household status can lower your tax bill by a meaningful amount because it gives you a bigger standard deduction and wider tax brackets than if you file as a single.

Supported Parent

If you’re unmarried and can claim a personal exemption deduction for supporting your mother or father under the rules explained in my earlier article, you can file as a head of household if you also pay over half the cost of maintaining the parent’s principal residence for the year. You need not live in the same household.

Other Supported Relative

If you’re unmarried and can claim a personal exemption deduction for someone other than a parent under the rules explained in the earlier article, you’re eligible for head of household filing status if you also pay more than half of the cost of maintaining a household that serves as the principal home for both you and the supported person for more than half the year. In other words, you and the supported person must actually live in the same household for more than six months for you to qualify for head of household filing status in the nonparent scenario.

Example: Say you’re unmarried and pay over half the support for your beloved 26-year-old niece during 2009. She is out of work the entire year and has less than $3,650 of gross income because her unemployment benefits run out partway through the year (in any case, the first $2,400 of 2009 unemployment benefits don’t count as gross income thanks to a temporary rule). You can claim a $3,650 personal exemption deduction for the supported niece on your 2009 Form 1040. So far so good, but there may be more. If your niece also lives in your household for more than half the year and you pay more than half the cost of maintaining that household (which you obviously do), you can use head of household filing status for 2009, thus providing a double tax-saving deal for you.