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New Tax Rules Make Dependency Exemptions More Valuable



In the past, the dependency exemption oftentimes was not worth fighting over; however, the changes in the tax law have stepped up the value of the dependency exemption in certain circumstances.

Beginning in 1998, parents can receive a yearly tax credit for each child under age 17 ($400 per child for 1998 and $500 per child thereafter). In addition, parents can take advantage of new educational expense credits which may result in thousands dollars for each child who attends college or graduate school. But there is a catch: divorcing parents can utilize these generous tax credits if -- and only if Ė the parent is entitled to the "dependency exemption."

This creates real potential value in the dependency exemption. For example, a six year old child will entitle the parent to 12 years at $500 credits ($6,000) in addition to possible education credits. And if there are two or three children, the value is even more attractive.

In the past, folks who divorced sometimes agreed to transfer the exemption from the custodial spouse -- who is entitled to the exemption -- to the non-custodial spouse -- who has the higher tax bracket so he or she could take advantage of greater tax savings. But this should not be done if the non-custodial spouseís income is high enough to cause a phase out of the exemption. And, to complicate matters further, the new credits phase out at lower income levels than does the exemption.


This means that a parentís total tax may be less if the exemption remains with the custodial -- or lower tax bracket -- parent under certain circumstances. Thatís why, if the custodial parent with a lower tax bracket wants the dependency exemption for one or more children, it might be possible to negotiate reduced alimony payments to her. For these reasons, calculations should be made on a case-by-case basis.

And there is yet another benefit that makes the dependency exemption more valuable: The ability to deduct interest on loans taken out to pay for a child's educational expenses that comes due and is paid after 1997. In order to qualify for this deduction, the taxpayer must claim the child as a dependent in the year in which the loan was taken out.

How much interest can be deducted? In 1998, the maximum is $1,000; in 1999, $1,500; in 2000, $2,000; and $2,500 per year thereafter. But Remember: You can only deduct interest that is paid during the first 60 months in which interest payments are required to be paid on the loan.

Adjusted Gross Income Phaseouts: These deductions phase out at the following levels: Joint filers, between $60,000 and $75,000; All other filers, between $40,000 and $55,000. After the year 2002, these amounts will be adjusted for inflation.

This is a basic outline of the new tax law and is not intended to be construed as either legal advice or tax advice. Because all situations are different, make sure to contact your tax advisor before making any decisions or taking any action.

© 1997, Flying Solo



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