Dependents, Head of Household, and Earned Income Credit Differences

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People often ask me about whether they can claim dependents, whether they qualify for the head of household filing status, and whether they qualify for the earned income credit. These three tax benefits are very closely related, as are designed to help minimized the tax burden for working families. The rules in this area often cause confusion, because each tax benefit has its own, separate requirements.

The first thing to start with is dependents, for that is a common element is all three tax incentives. Both head of household and the earned income credit require that a taxpayer claim (or be eligible to claim) dependents. Dependents are, roughly speaking, persons who depend on another for their financial support, and the usual example here are children. But sons and daughters aren't the only types of relationships that can exist between a taxpayer and a dependent. Parents, grandparents, nieces and nephews, and other family relations can also qualify. The important thing to remember about dependents is there are two ways to qualify as a dependent: either under the qualifying child criteria or under the qualifying relative criteria.  Claiming a dependent opens several tax saving benefits to a taxpayer: the taxpayer gets to claim one personal exemption for each dependent, and may also be eligible for the earned income credit, child tax credit, child care tax credit, education tax credits or deductions for that dependent, and medical expenses for that dependent.

(By eligible to claim a dependent, I am referring to the situation where a custodial parent may waive the dependent's personal exemption in favor of the other parent, but retain eligibility for head of household and the earned income credit, a situation I call sharing the dependent-related tax breaks.)

Head of household is a separate tax benefit, one that functions by widening the income brackets to which each tax rate applies.

For example, compare the income brackets for single and head of household filers found in the 2011 tax rates. To be eligible for head of household status, a taxpayer must have at least one dependent and be unmarried. So, this tax benefit is particularly well-suited for single parents. Now dependents can be of any number of family relations, but for Head of Household, the dependent must be closely related to the taxpayer by birth or marriage, such as children, parents, grandparents, nieces and nephews. There's a further restriction for Head of Household in that the dependent person must actually reside with the taxpayer, and the taxpayer must actually provide more than half of the total financial support of the dependent person. These two requirements are not always the case for dependents. For example, parents can be claimed as dependents under the qualifying relative criteria, and the parents don't necessarily need to reside with the taxpayer. But for head of household purposes, parents would need to reside with the taxpayer if the taxpayer wants to use them as their qualifying person.

The earned income credit is a refundable tax credit for lower-income families that in many cases results in the taxpayer having a negative effective tax rate, in other words that the taxpayer receives more back from the IRS than they paid in through income tax withholding.

For the purpose of the earned income credit, only closely-related dependents will qualify. Specifically, children, grandchildren, brothers and sisters, nieces and nephews can qualify a taxpayer for the earned income credit. But parents, grandparents and other types of relationships won't qualify due to the age test, in which the dependent person must be under 19 or under 24 and a full-time student.

What often causes frustration are situations in which a taxpayer is caring for a younger person, but there's no relation by blood or marriage. In such cases,  taxpayers might find they are eligible only for the single filing status and the dependent's personal exemption, but not head of household or the earned income credit.

Tax preparation software often includes questionnaires to help taxpayers determine whether they are eligible to claim a dependent, eligible for head of household, and eligible for the earned income credit.

Many of these interview questions may seem repetitive, but that's because in each case the criteria are slightly different. The IRS has a Web tool for helping taxpayers figure out if they qualify for the earned income credit, called the EITC Assistant. But the IRS does not have (as far as I'm aware) similar Web tools for evaluating dependents and head of household situations.

Related: Can two people at the same address both be head of household?