          
          
          
                          The Family & Deductions
          
          
          10) The dependency exemption for supporting older
          relatives or unrelated taxpayers is more important
          every year.  This write-off is not new, but it was
          worth only $1,000 or so in the past.  Under tax reform
          it was worth up to $2,000 in 1986, and that figure is
          indexed annually for inflation.  (It is worth $2,450
          for 1994.)  To claim an exemption for a relative, you
          don't have to live with that relative.  But you do have
          to pay over half that person's support for the year. 
          Someone who isn't related to you can be your dependent
          if he or she lives with you for the entire year and you
          furnish over half the support.  In addition, the person
          cannot file a joint return with a spouse and must not
          earn more than the personal exemption amount during the
          year.
               Payments to a nursing home qualify as support, as
          do payments directly to the dependent or to someone
          providing goods or services to the dependent.  Money
          earned by the dependent does not count as support
          unless he or she actually spends it on necessities such
          as food, clothing, shelter, and medical care.  If the
          income is put in a bank or other investments, it
          doesn't count as support.  In addition, tax exempt
          income such as Social Security income does not count
          towards the income limit of the personal exemption
          amount.
               Suppose you and your brothers and sisters support
          a parent jointly, but nobody provides more than 50% of
          the support.  In that case you can sign a multiple
          support agreement in which you all decide who gets the
          dependency exemption.  Anyone giving more than 10% of
          the year's support can be assigned the exemption. 
          Everyone who gives more than 10% must join in filing
          Form 2120 to assign the exemption.  You must requalify
          for and refile the multiple support agreement each
          year, and the person who is assigned the exemption can
          change each year.
          
          11) A dependent can earn over $2,450 tax free and still
          be claimed on your return.  When a child is under age
          19 or a college student, the gross income limit does
          not apply.  That means the child can earn an unlimited
          amount of money and still be claimed as your dependent
          if you provide over one half the child's support.  The
          child is not allowed to claim the personal exemption,
          if you claim it.  But the child can take the standard
          deduction.  The deduction can offset up to $600 of
          unearned (investment) income, and all of the deduction
          can offset earned income, such as salaries and wages,
          up to the standard deduction amount.  These dollar
          amounts are indexed annually for inflation.
          
          12) It is still easy for a self-employed person to
          deduct a child's allowance.  Tax reform puts
          restrictions on giving income to children under age 14,
          but the limits don't apply if the child earns the
          money.  You can employ your child in the business and
          deduct the wages you pay as long as the wages are
          reasonable payment for the work actually done by the
          child.  The courts have upheld the right of family
          businesses to employ children as young as six years of
          age as long as the children do work within their
          capacities and are paid no more than they would be in
          an arm's length transaction.  The pay is taxable to
          them.  But they will have a lower tax rate than you and
          can earn over $3,800 annually without paying any taxes. 
          Be certain to keep excellent records of their working
          hours and the tasks they perform.
          
          13) Income splitting -- the most underused tax angle of
          all -- gets new life after the 1993 tax changes. 
          Income splitting is when someone in a high tax bracket
          transfers income-producing property to someone in a
          lower tax bracket, usually a child or grandchild.  That
          reduces the family's total tax burden.
               Income splitting's attractiveness declined after
          the Tax Reform Act of 1986, when there were only two
          tax brackets of 15% and 28%.  But the 1990 tax law
          added a 31% bracket, and the 1993 law added 36% and
          39.6% brackets.  The large difference in tax rates
          makes income splitting more attractive to higher income
          taxpayers than it has been in years.
               But you must work around the Kiddie Tax to get the
          benefits of income splitting.  When a child under the
          age of 14 earns investment income, the first $600 is
          tax-free, protected by the standard deduction.  The
          next $600 (indexed for inflation) is taxed at the 15%
          rate.  But investment income above that amount is taxed
          at the parent's top marginal tax rate.  Or the parent
          can elect to add the income to his or her own gross
          income.
               Therefore, to get the benefits of income
          splitting, you should give a child under age 14
          property that will produce little or no income until
          the child turns age 14.  This could include real
          estate, tax-exempt bonds, growth stocks, precious
          metals, and collectibles.  U.S. savings bonds also will
          defer income.  Another option if you have real estate
          is to put the property in a corporation, then give the
          child the corporate stock.  When the child turns age
          14, the corporation can begin to pay dividends or it
          can elect S corporation status.  In those cases, the
          income will be taxed at the child's tax rate.  
                With each of these methods you do not have to
          give the property directly to a young child.  The
          property can be put in a trust or a custodial account
          under the Uniform Gift to Minors Act.  With a custodial
          account, you or any other adult serves as custodian
          until the child reaches the age of majority.  That
          means the adult manages the property.  But once the
          child reaches 18 or 21, depending on your state, you
          have no control over what is done with the money.  A
          trust can keep the child from getting the control until
          much later.  In order to work, the trust must be
          irrevocable, which means you cannot get the property or
          income back.  It is best that the trustee be someone
          other than you or your spouse.  You also should not
          have any transactions with the trust, such as getting
          loans or selling assets.  When a large amount of money
          is at stake, you probably should set up a trust.  But
          for smaller sums the custodial account is better
          because it is simple and has few overhead costs.
          
          14) Alimony is deductible; child support is not.  Be
          sure your payments qualify as alimony and avoid the new
          IRS crackdown.  Each year about 500,000 taxpayers claim
          alimony deductions, but only 350,000 report receiving
          alimony payments as income.  Therefore, the IRS has
          concluded that a number of people are either
          overstating alimony payments or understating alimony
          income.  New rules became effective in 1985, but they
          were so complicated that Congress changed the rules
          again.  For divorce and separation agreements after
          1986, an alimony payment is deductible if it is paid in
          cash, is not for child support, and the obligation to
          make payments terminates on the death of the recipient. 
          Unlike pre-tax reform law, the termination of payments
          at death need not be explicitly stated in the divorce
          or separation agreement.  A payment is considered to be
          paid in cash even if it is paid to a third party that
          provides goods or services instead of being paid
          directly to the recipient spouse.
               Tax reform also revised the "recapture" rules. 
          These revised rules require payments to be spread out
          in order to be deductible.  The payments must be made
          over at least a three year period.  Further, the
          payments in the first year cannot exceed the average of
          the second and third year payments plus $15,000.  The
          amount of payments in the second year cannot exceed the
          third year payments plus $15,000.  Any excess alimony
          payments that were deducted in a prior year must be
          added to your ordinary income the following year.  The
          purpose of this rule is to ensure that nondeductible
          property settlements are not disguised as deductible
          alimony payments.  After the third year, payments can
          be made in whatever amount the parties agree to.
               The IRS often will try to recharacterize some
          alimony payments as nondeductible child support.  It
          can do this in three instances.  The first instance is
          when the separation agreement or divorce decree
          specifically states that the payment is child support. 
          The second instance is when an alimony payment declines
          as a result of a particular event happening to the
          child.  The event could include the child's reaching a
          particular age, getting a job, or graduating from
          school.  The third instance is when the payment
          declines at a particular time that is clearly
          associated with an event related to the child.  For
          example, the divorce agreement might state that alimony
          payments are reduced on June 20, 1995, and it turns out
          that the child turns 21 during June 1995.  The lesson
          is to be careful about alimony payments that decline
          over the years.  Be sure that there is no implication
          that the declines are related to changes in your
          child's life.
          
          15) Child care & dependent expenses still result in
          major tax reduction.  When child care expenses are
          incurred to enable a taxpayer to work while a dependent
          is cared for, a tax credit is available.  When a
          taxpayer is a full-time student, the credit is more
          valuable than a deduction because the credit directly
          reduces your tax bill.  You can get a credit of 20% to
          30% (depending on your income) of the first $2,400 you
          spend on the care of a child under 13 years of age (15
          for tax years before 1989).  When you have more than
          one child, the credit is available against up to $4,800
          of expenses.  But the credit is not allowed for the
          costs related to a dependent's overnight stay at a
          camp.  If you participate in a dependent care
          assistance program run by your employer, your qualified
          child care expenses that are eligible for the credit
          must be reduced by any benefits received under the
          employer plan.  To protect your child care credit, make
          sure you have the day care provider fill out form W-10,
          available from the IRS.
          
          
          
