Federal Exemptions: How Many Can I Claim?by Bryan Carey
Dec 22, 2001 (Updated Jan 29, 2010)
The Bottom Line Exemptions help reduce your taxable income and they can save you a substantial amount of tax, depending on the number of exemptions you can legally claim.
The year 2001 is quickly drawing to a close, and with the end of the year comes the reality of preparing to file your tax returns for the 2001 tax year. In just a few short weeks, we will all be receiving our W-2 forms in the mail and we will be looking for ways to reduce our tax burden.
Several methods exist for cutting your taxable income down to size, but one of the most frequently used is exemptions. Even if you don’t plan on itemizing deductions, you are still entitled to reduce your taxable income through the use of exemptions.
What are Exemptions?:
Exemptions come in two types: personal exemptions, and exemptions for dependents. Personal exemptions include those taken for yourself, and for your spouse, if you are married. Everyone is entitled to take a personal exemption unless he/she can be claimed as a dependent on someone else’s tax return.
Each one of your dependents also qualifies as an additional exemption. To determine whether or not someone qualifies as one of your dependents, he/she must meet the following set of criteria:
Member of Household: The individual must have lived with you for the full year, as a household member, or be a relative of yours.
Citizen or Resident: The individual must be a U.S. citizen or resident (or a resident of Canada or Mexico) for at least a part of the tax year that you are filing your return.
Joint Return: The dependent cannot file a joint return. The only exception to this would be in the case of a dependent who files a joint return, along with his/her spouse, simply as a claim for a tax refund when in fact there would be no actual tax liability for either individual (dependent or spouse) if he/she filed a separate return.
Gross Income: The dependent cannot have gross income over $2,900 in 2001 unless he/she is under 19 years of age or a student under age 24 at the end of the year.
Financial Support: The dependent must be receiving more than half of his/her financial support from you for the past year. There are two exceptions to this rule. One exception would be if there are two or more people providing support, but no one person is providing half of the support (for example, if a student earned $3000 for the year, and received $2000 in support each from two different people, then no one person has provided half of the total support of $7,000). Another exception would be if the person receiving support is the child of divorced or separated parents.
Remember that the dependent must meet all five of the above conditions, to qualify as an exemption.
How Much are Exemptions Worth?:
For the 2001 tax year, each exemption that you claim will reduce your taxable income by $2,900. You need to keep in mind that this is a reduction in taxable income, not a $2,900 reduction in your tax liability. You simply take your number of qualified exemptions, multiply by 2,900, and reduce your taxable income by the total amount. If you are married filing a joint return and have one child, for example, then your total exemptions would be 3, multiplied by $2,900, equals $8,700 in taxable income reduction.
Do Exemptions Have Much Impact on Taxes?:
Since exemptions reduce your taxable income, they have the greatest impact (if you base it solely on actual dollars saved) on those who are in higher tax brackets. If an individual is in the 36 percent tax bracket, then each exemption will reduce his/her tax liability by $1,044 (.36 times 2,900). If an individual is in the 15 percent bracket, then each exemption will reduce the tax liability by $435 (.15 times $2,900). The greater your tax rate, the more each exemption will save you in taxes.
Even though the actual tax dollars saved per exemption is less for those in lower tax brackets, the relative savings (in percentage terms) is greater, and that's why exemptions tend to be most beneficial to lower income individuals. For example, let's say that you are in the 15 percent tax bracket, and your taxable income (before exemptions) is $10,000. This would make your tax liability for the year $1,500. But if you had three exemptions, your taxable income would be reduced to only $1,300 ($10,000 less $8,700 in exemptions), which would lower your tax liability to only $195. That's a savings of 87 percent in tax, money that could really come in handy for a lower- income individual. For an individual in a higher bracket, the total dollars saved with three exemptions would be greater, but stated in percentage terms, it would be much less than 87 percent.
Tax exemptions can make a difference in your tax liability. They reduce your taxable income, and hence, your Federal tax liability. Exemptions can greatly benefit those who have a large number of dependents. Sometimes, if taxable gross is low enough already, the additional exemption reduction from having a large number of dependents can possibly be enough to reduce the individual’s tax liability to zero.
Try to claim as many exemptions as you possibly can, making sure to stay within the legal boundaries defined by the IRS. Even if your tax liability is reduced by only a small amount, it’s still better than nothing. The IRS won’t be hurting, so try to take advantage of all the tax- reducing options that are available, and reclaim some of your hard- earned income.
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