If you're helping out a financially stressed relative, you're doing a good thing. In return, you might be entitled to some tax breaks that do you some good. Please read this to find out if you qualify. (This is the second instalment of our two-part series on this subject; here's the first episode.
Claim Deduction for Paying Relative's Medical Expenses
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). If your expenses don't exceed that threshold, you get no write-off. (AGI is the number on the last line of page 1 of your Form 1040.) While clearing the 7.5%-of-AGI hurdle is usually difficult, it can be much easier if you pay medical expenses for a qualifying relative. Why? Because you get to count the medical expenses you pay for that person plus all of your own expenses.
Figuring Out If You Have a Qualifying Relative
For a person to be your qualifying 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.
Add Up the Expenses and Claim Your Deduction
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.
Supporting a Relative May Also Allow You to Use Favorable Head of Household Tax Filing Status
A common (and expensive) error committed by unmarried individuals is filing as a single taxpayer when you could file as a head of household (HOH). In these tough economic times, HOH status may be available to you for the very first time because you're now supporting a struggling parent or out-of-work relative. If so, you want to file as an HOH because it gives you a bigger standard deduction and wider tax brackets than if you file as a single. These differences can lower your tax bill by a meaningful amount.
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 an HOH 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 HOH filing status if you also pay over half the cost of maintaining a household that serves as the principal home for both you and the supported person for over half the year. In other words, you and the supported person must actually live in the same household for over half the year for you to qualify for HOH filing status in the non-parent scenario.
Example: Say you're unmarried and paid over half the support for your beloved 26-year-old niece during 2011. She was out of work the entire year and had less than $3,700 of gross income. You can claim a $3,700 personal exemption deduction for your niece on your 2011 Form 1040. So far so good, but there may be more. If your niece also lived in your household for over half the year and you paid over half the cost of maintaining the household (which you obviously did), you can use HOH filing status for 2011 based on supporting your niece and maintaining the household where you both lived. It's a tax-saving double play.
The Last Word
The rules allowing tax breaks for supporting relatives have been around for many years, but you might not have ever needed to know before the economy went into the tank and stayed there. For more details, see IRS Publication 501 (Exemptions, Standard Deduction, and Filing Information) at www.irs.gov.