The Rules for Claiming Personal Exemptions Through 2017

It might not feel like it at tax time, but the Internal Revenue Service doesn't actually tax you on every single dollar you earn. The Internal Revenue Code offers numerous deductions you can use to shave away some of your income and the IRS only taxes you on the balance.

Personal exemptions used to be one form of deduction you could use to reduce your taxable income. This in turn lowered the amount of income tax you'd have to pay because you'd be paying taxes on less money. Unfortunately, that's not the case going forward, at least for a while. 

The Tax Cuts and Jobs Act eliminated the personal exemption from the tax code when it went into effect in 2018. This will be the case from through the 2025 tax year when the TCJA technically expires. But it's expiration isn't necessarily a done deal. Congress has the option of renewing the tax law for another stretch of years at that time. 

But you're still in luck if you haven't filed your 2017 tax return yet or if you want to go back to amend previous years' returns. Here's how the exemption works. 

All tax breaks come with a whole list of rules for claiming them and personal exemptions are no exception. A taxpayer is permitted to claim one personal exemption for himself and one exemption for each person he's able to claim as a dependent.

Married people who file jointly can claim two personal exemptions, one for each spouse, plus exemptions for each of their dependents. If they file separately, however, one spouse can claim the other spouse's personal exemption only under limited circumstances.

You can't claim a personal exemption for yourself if you're someone else's dependent because that taxpayer is already claiming your personal exemption.

The personal exemption amount was indexed for inflation—it increased slightly from year to year to keep pace with the economy, although if the economy remained relatively steady, the personal exemption amount also stayed the same. This happened in tax years 2016 and 2017 when it remained stuck at $4,050 for tax years 2016 and 2017. 

Here's how the exemption worked out in previous years:

Personal exemptions are subject to phase-out limits called the personal exemption phaseout or PEP.

Phasing out means that the exemption gradually reduces by 2 percent for each $2,500 or fractional portion of $2,500 by which a taxpayer's adjusted gross income for the year exceeds a certain threshold. The personal exemption phases out by 2 percent for each $1,250 of adjusted gross income over the threshold for people who use the married filing separately status. 

Here's an example of how this works. Let's say Darla had adjusted gross income of $300,000 in 2017. She filed as head of household and claimed two personal exemptions, one for herself and one for her daughter. The relevant threshold for 2017 was $287,650 for head of household filers. Darla's adjusted gross income of $300,000 exceeded this threshold by $12,350.

We take this excess amount and divide it by $2,500, which comes out to 4.94. We must therefore reduce her personal exemptions by two percent for each $2,500 or fractional part of $2,500, which works out to five reductions of 2 percent: five whole multiples of $2,500 plus one fractional part of $2,500.

Darla therefore had to reduce her personal exemptions by 10 percent: ($4,050 + $4,050) x 10 percent, or $810. So Darla's two personal exemptions which totaled $8,100 before the reduction were worth only $7,290 after the phase-out limit—$8,100 less $810.

The phase-out limits did not apply in 2010, 2011, or 2012. 

Personal exemptions show up in two places on the 2017 tax returns and those for previous years, first on page 1 of Form 1040. Line 6 has a space where you can indicate whether you're claiming personal exemptions for yourself, your spouse, and/or for your dependents.

Next, the deductible amount of your personal exemptions shows up on the second page on line 42, or on line 26 if you file Form 1040-A.  Personal exemptions show up in just one place, on line 5, for taxpayers who file Form 1040-EZ.

The IRS has announced a brand new Form 1040 for the 2018 tax year, intended to accommodate the new tax law and replace the old 1040, the 1040-EZ, and Form 1040-A. Because there's no personal exemption in 2018, there are no lines on this new form for entering your personal exemptions or their amount. 

Personal exemptions can only reduce federal income tax. They don't reduce the alternative minimum tax, sometimes called the AMT. Taxable income for AMT purposes is calculated without regard to personal exemptions.

At first glance, it would appear that a lot of taxpayers will be handing over a lot more in tax dollars beginning in 2018. A qualifying family of four was able to subtract $16,200 off their income by claiming personal exemptions in 2017. 

That same family was able to claim a $12,700 standard deduction in 2017, assuming mom and dad were married and they filed a joint married return. The TCJA has increased that standard deduction to $24,000 in 2018. This move was intended to help recapture at least some of that lost exemption amount. Our theoretical family has just reclaimed $11,300 of the $16,200 it lost by not being able to claim personal exemptions. 

Tax brackets changed and became slightly more generous under the TCJA as well. The bottom line is that the loss of personal exemptions might be offset by other provisions for at least some taxpayers, but only time will tell.