By Bob Palechek, CPA | October 11, 2019

Tax Credit for Other Dependents: Tests and Tips

Tax preparers are seeing more and more people caring for their adult children or aging parents and want to claim the ‘Other Dependent’ tax credit. Let’s take a closer look at how it works.

Starting in the tax year 2018, the Tax Cuts and Jobs Act (TCJA) brought with it some good news related to taking the tax credit on other dependents who cannot be claimed for the Child Tax Credit. The new tax credit is valued at $500, plus possibly dependent care expenses. However, this is the tax code so – no surprise – a series of ‘tests’ must first be satisfied.

Tests You Must Pass to Claim a Dependent

There is really only one test you must pass to be able to claim a dependent: you cannot be claimed simultaneously as a dependent by someone else. All other tests fall upon the person who you want to take as a dependent.

Tests Your Dependent Must Pass for You to Claim Them

Assuming you are qualified to claim a dependent, then your child (or another qualifying person) must pass seven tests. For simplicity, we will refer to this person as ‘the child.’

  • Relationship Test
    • Son, daughter or a descendant of them.
    • Brother, sister or a descendant of them.
    • Parents, grandparents, siblings of parents or in-laws can also qualify as a qualifying relative.
    • A person not related to you in any way can still be claimed as your qualifying relative if they lived with you the entire year.
  • Age Test
    • Below age 19.
    • Below age 24 and a full-time student.
    • Any age and permanently and totally disabled. An individual is considered ‘permanently and totally disabled’ if he or she meets Social Security’s requirements as being unable to engage in any substantial gainful activity because of any medically determinable physical or mental impairment that can be expected to last for a continuous period of at least 12 months. A physician should substantiate the impairment. It’s a good idea to get a note from your doctor and keep it in your tax file.
  • Residency Test: The child must live with you for at least half of the year. Temporary absences due to illness, education, etc., are not considered.
  • Nationality Test: The child must be either:
  • A U.S. citizen, national or resident alien.
  • A resident of Canada or Mexico.
  • Support Test: The child cannot be providing more than half their support (scholarships, whether taxable or not, are not included in this).
  • Joint Return Test: The child cannot be filing a Married Filing Jointly return with a spouse (unless they are only doing so to claim a refund of tax withheld).
  • Tie-breaker Rules: If the child is a dependent of more than one person (as in the case of divorced parents), the tie-breaker rules will need to be followed.

While most of these tests are pretty straightforward, the Support Test warrants a little more discussion.

How to Determine the ‘Support’ Aspect

Determining the ‘support’ aspect of the qualifying tests for the ‘Other Dependent’ tax credit follows a specific process:

  • Total up all the expenses the child has (not their income). Include all of the following that they would be paying if they lived on their own:
    • Shelter, including rent at fair market value, utilities, repairs. Do not include your mortgage, property tax or insurance.
    • Medical and dental expenses above and beyond what is being paid by insurance.
    • Educational costs.
    • Other, such as travel and recreation.
  • Next, identify who is paying for which of the above: you or the child? All sources of income, even those excludable from taxable income, are included. For example, they would consider Social Security disability benefits if they are using them to cover their expenses. Also, you would include tax-exempt interest income and payments received under a state Medicaid program if you are using them to cover the child’s expenses.
  • It’s important to remember that you are identifying what source of money is actually being used to pay the expenses. If you have decided as a family that the child will put their disability income away into savings and that you will cover all of their living expenses, then none of their disability is considered support.
  • When you total up all of the child’s expenses, if you are covering more than half of their support, then the Support Test has been met.

How to Handle the Cost of Shelter

It is usually beneficial to charge the child rent because doing so will maximize their Social Security disability benefit. If you don’t, the value of the fair market rent they are not paying will be considered income to them and will be included in their income and resources for benefit amount purposes.

Rental income received from your child – or anyone – must be reported on your tax return. Where it goes on the return, however, makes a big difference in how and what can be reported.

Rent at fair market value – This is the amount of rent most people would pay in your area for the space provided. Amounts will vary greatly depending on whether you are renting the child a guesthouse, a basement or perhaps just a bedroom. If you are renting at fair market value, then you are deemed to be conducting business in pursuit of profit. Business income of the rental type is reported on Schedule E.

Here you can report not only income but all associated expenses like the utilities, cleaning, repairs, mortgage interest, property tax, insurance and depreciation as a proportion of the whole based on square footage. All of these expenses can get you down to no taxable income and sometimes even result in a tax loss.

Rent below fair market value – Rents below fair market value are not considered business income but rather Other Income and are reported directly on the 1040 form by way of Schedule 1. The limitation here is that you cannot take any expenses against this income, so the full rent amount is taxable.

Before enactment of the TCJA, expenses against Other Income could be taken on the Schedule A as Miscellaneous Itemized Deductions (but only the amount exceeding 2% of AGI, of course). Since 2018, however, itemized deductions are no longer allowed.

Taking the ‘Other Dependent’ Tax Credit

Assuming all the required tests are met, you can claim a $500 credit for each ‘other dependent.’ Do note that this credit is non-refundable so, if you didn’t have any taxes withheld or otherwise pay in anything during the year, you would not be able to get this credit.

Also, since this is a credit and not a deduction, you calculate your taxes owed and subtract $500 right off the top!