Small business owners can reduce their overall tax liability by maximizing deductions, credits, exemptions, and applying their standard or itemized deduction. The two most common methods for reducing tax liability and the ones for which all taxpayers qualify are the standard deduction and the exemption. Fortunately, the process for applying the standard deduction and exemption amount to your tax return is reasonably straightforward.
Exemptions reduce taxpayer’s overall taxable income. In most instances, taxpayers are allowed an exemption for themselves, their spouse and any dependents listed on their income tax returns. The exemption amount is the same ($3,650 for tax year 2009) across the board. The standard deduction amount also reduces a taxpayer’s tax liability but unlike the exemption amount, it is based on the taxpayer’s filing status.
The standard deduction amount and the exemption amount are claimed on the taxpayer’s 1040, 1040A or 1040Ez. For most small business owners, the IRS Form 1040 will be used since this is the form most commonly used with Schedule C, Profit or Loss from Business. Your standard deduction is claimed on Line 40a of your income tax return while your exemption amount is claimed in the “Exemptions” section of your return.
Additional standard deduction amounts for taxpayers who are blind or age 65 or older at the end of the tax year are available. Taxpayers who are 65 and blind get an additional standard deduction amount for both categories. In contrast, the exemption amount is a set amount and does not increase or decrease unless there is a change to the taxpayer’s filing status. However, the exemption amount does phase out once a taxpayer’s adjusted gross income reaches a certain level.
To be claimed as a dependent exemption on a taxpayer’s return, he must be a qualifying child or a qualifying relative. To be defined as a qualifying child, the dependent must pass the IRS’s relationship, age, residency, support, joint return, special test. To be eligible to be claimed as a qualifying relative, the person must be related to you or live in your household, must have income below $3,650, must not be your qualifying child and must be a person for whom you provided most of the support.
A taxpayer’s exemption can only be claimed on one tax return per tax year. For example, if you claim your child, then she cannot claim her own exemption. If your child is required to file a return, then she will need to claim -0- as the exemption amount on their own tax return.