February 8, 2012 / 4:00 PM / 6 years ago

Tax tips for the sandwich generation

By Lynn Brenner

Feb 8 (Reuters) - When Barbara McCabe’s 28-year-old daughter and two grandchildren were evicted from their home two weeks before Christmas 2008, she emptied her 401(k) account to buy them a house in Beacon, New York, near her home in Bedford Hills.

“It needed a new roof, and there were no kitchen appliances, but it was like divine intervention that I got a mortgage and a $50,000 loan to fix it up,” says McCabe, a 61-year-old paralegal. “I was so bowled over at the closing, I went right into the hospital with asthma!”

In Coral Gables, Florida, Martina Schramm and her husband spent their savings on her father’s medical care. After he died, they bought a bigger house so her mother could move in with them. “It’s $1,100 more a month, but we needed a bedroom and bathroom on the first floor for her,” says Schramm, a 61-year-old marketing consultant. She worries about how they’ll manage in two years with two sons in college. “I‘m sure there are a lot of the same stories out there,” she adds.

Indeed, there are. In this tough economy, it’s not unusual to find baby boomers who are also part of the sandwich generation -- squeezed from both sides. About 30 percent now contribute financially to their parents’ care, according to the Pew Research Center. An even larger percentage provide financial support to adult children.

Yet millions of taxpayers overlook potential tax deductions for helping family members, says Mark Steber, chief tax officer at Jackson Hewitt Tax Services.

* Each dependent you claim cuts your taxable income by at least $3,700 -- and your children and parents don’t have to live with you to qualify as dependents. On the other hand, determining whether you meet the Internal Revenue Service requirements can be the equivalent of threading a needle in dim light. Here are the basics.

Your children are your dependents if they were under 19 at the end of 2011 or if they were full-time students and no older than 24. They must have lived with you for more than half the year and provided no more than 50 percent of their own support. For example, if you, your ex-husband, and your 23-year-old daughter each paid one-third of her expenses, and she meets the other requirements, she’s your dependent or you ex-husband‘s.

A child older than 24 (or a parent) is your dependent even if she doesn’t live with you, as long as you provided more than half of her support. She also must not file a joint return with anyone else except to claim a refund, must be a U.S. citizen or resident alien and have a 2011 gross income that doesn’t exceed $3,700.

* If you can claim your child as a dependent and have a modified adjusted gross under $61,000 if you’re single or under $122,000 if you’re filing jointly, you qualify for a lifetime learning credit.

The credit will offset up to $2,000 of her college or graduate school expenses, even if you aren’t paying them, says Bob Scharin, a Thomson Reuters tax analyst. “Payments by the dependent child or by a third party, like grandparents, would be treated as having been made by the parents,” he says.

* You can also claim all your dependents’ medical expenses. True, you can only deduct medical costs that exceed 7.5 percent of your adjusted gross income, but an aging mom or dad may put you over that threshold. Deductible medical expenses include the cost of disability-triggered home improvements like ramps, wider doorways and stair-lifts, says Bob Leins, a Rockville, Maryland, certified public accountant.

* Is there a tax break for becoming your adult child’s mortgage lender? Not for you, but he gets a mortgage interest deduction if you do it right. John Lindbloom, a tax principal at Huber, Ring, Helm & Co in St. Louis, has seen parents become the mortgage lender for adult children unable to refinance homes that are under water (worth less than they owe). The kids get a low market rate (about 4 percent), and these days, that’s a high return for the parents.

“Make sure your children sign a note for the loan and have the mortgage recorded so there’s a lien on the house,” says Lindbloom. “They can’t claim a home mortgage interest deduction unless the loan is secured by the property.”

* What if you pay mom’s living expenses but she doesn’t live with you? She can be claimed as a dependent if you paid more than half her support and her income didn’t exceed $3,700, excluding tax-exempt Social Security benefits and municipal bond interest. She has to be a citizen or resident alien and must not file a joint return with someone else unless it’s to claim a refund.

If you and your siblings share that cost, and you each provide more than 10 percent of her support, you can take turns claiming her as a dependent by filing a form called a Multiple Support Declaration with the IRS. Many families assign mom to the sibling with the highest tax rate or the one who pays the most.

Even if mom’s income is too high for you to claim her as a dependent, you can deduct her medical expenses if you paid more than half of her support, and she’s a U.S. citizen or resident alien. If you pay for her care in an assisted living residence, her room and board may also be deductible, if her living there is deemed medically necessary. Ask the facility how much of its monthly cost is attributable to deductible medical expenses.

* Finally, make sure you use the right filing status. If you were unmarried at year-end and can claim an exemption for an adult child who lives with you, or for your mom, you may be able to file as a head of household. That lowers your taxes. If you earn $70,000 a year, filing as head of household rather than a single taxpayer saves you about $2,000 in 2011 federal tax.

These tax breaks don’t cover the true cost of mom’s assisted living residence, or of keeping your 20-something child in cell minutes and health insurance, but they help a little. And if you’re a hard-pressed baby boomer, you need all the help you can get.

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