Can we claim my adult sister and her minor daughter on our tax return? They have lived with us for a year.

[elismommy13]

My sister has lived with us for a year with her youngest daughter.
I provide dinners M-F for my niece. My sister pays rent/day care to me ...around $800/month. She is not halving any household bills.
Can I claim them on mine and husbands joint tax return?

[Hal_Al · Accepted solution]

Simple answer: No.

Longer answer: Maybe. 

From your description, it sounds like you sister has a job and she probably made more than $4050 for the year. That would disqualify her from being your dependent, unless she was a full time student; in which case a different set of rules would have to be looked at.

Your niece can be the qualifying child dependent of any relative in her household. So you sister gets to decide whether to claim the child herself or let you (& your spouse on a joint return) claim her. This assumes you & your spouse have a higher income than your sister. 

One thing you can do is prepare returns both ways to see which way the family comes out best. You can use this tool: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/?s=1. 

You first thought might be that the taxpayer in the highest tax bracket would come out best. But because of today's convoluted system of tax credits, that's probably not going to be the result in your case.

 

[Hal_Al]

You didn't ask, but I'll tell you anyway: You do not have to claim the day care money as income. You can treat it as an expense sharing arrangement between family members. But, if you sister wants to claim the day care credit, you will have to claim the income. In addition to income tax, you will have to pay social security and medicare tax, unless the total amount she paid you was less than $2000. Then, you would just have to pay income tax.

[Hal_Al]

There's actually a third choice in who claims the child. Your sister could allow the non-custodial father to claim the child as a dependent. He would also claim the Child Tax credit; but your sister could still claim the Earned Income Credit and the Dependent Care credit.
The  parents can split the child, under a special for divorced ans separated parents; but you & your sister cannot.