Those Vexing Tax Terms...Exemptions, Deductions, Dependents, Oh My!
How can you legally cheat the taxman? Here are two ways to reduce your taxable income legally!
- Exemptions: Think of exemptions as related to people. For example, your parents can reduce their taxes by $4,050 (2016 rate per exemption) for every person in the household (including children and relatives that qualify as Dependents). So in 4 person household (Mom/Dad) and two kids, the parental income can be reduced by $16,200 ($4,050 X 4).
- In fact, my Dad would contribute to our college fund based on the amount of the after-tax impact of exemptions. So, reducing his income by $4,000 for each child, saved him about $1,200 in taxes if he was in 30% tax bracket so that is what he would give to us.
- Here’s a helpful formula: Total Exemptions = Personal Exemptions (parent + spouse) + Dependent Exemptions (child or relative)
- How many exemptions do you think your parent(s) can take given your family situation?
- Tax Deductions are another way to reduce your income. Tax Deductions are expenses incurred by the taxpayer for things like contributions made to charity, student loan interest deduction or mortgage interest deductions. Tax policy uses deductions as a way to encourage certain behavior (e.g., giving to charity, going to college and owning a home).
- Think of Dependents as a subset of Exemptions. Each Dependent = one exemption.
- Who can be a dependent: Qualifying child (rules below) or qualifying relative (rules below)
- Here is a fifteen minute online interactive that you can use to determine who is a dependent (tough sledding for high schoolers!)
- If you are dependent on your parent(s) tax return, then you cannot claim a personal exemption
- To itemize means to add up your EXEMPTIONS and TAX DEDUCTIONS
- The STANDARD DEDUCTION is a number the U.S. tax law says you can use to reduce your income based on your filing status:
- For single person: $6,300
- Married (filing jointly): $12,600
- I purposely left out head of household or married filing separately
He should take standard deduction! In fact, he would have no taxable income, since his earned income of $4,000 is below the standard deduction of $6,300. If he paid federal income tax during the year, he would receive a refund.
About the Author
Tim Ranzetta
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.
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