Bottom line is, the dependent will file their own tax return. You can't include both of your incomes on one tax return, any way you look at it. Since the dependent has more than $6,350 of their own income, they are required to file their own return. However, if they qualify to be claimed as a dependent on someone else's return, then they don't qualify for their self exemption and must select the option for "I can be claimed on someone else's return".
It doesn't matter if they are claimed as a dependent on your tax return or not. If they "qualify" to be claimed as a dependent on your tax return, then that dependent can not take their self-exemption.
For your tax return, since you do have reportable income your tax return must include both your backpay amount received in 2017, and your SS received in 2017. You already say you won't pay taxes on the SS, meaning that your backpay is less than the cutoff. So this shouldn't be a problem for you. Keep in mind that for your itemized deductions to kick in, they have to exceed your standard deduction.
Tax Formula. Here’s a quick way to find out if a taxpayer must pay taxes on their Social Security benefits: Add one-half of the Social Security income to all other income, including tax-exempt interest. Then compare that amount to the base amount for their filing status. If the total is more than the base amount, some of their social security benefits may be taxable.
Base Amounts. The three base amounts are:
- $25,000 – if taxpayers are single, head of household, qualifying widow or widower with a dependent child or married filing separately and lived apart from their spouse for all of 2016
- $32,000 – if they are married filing jointly
- $0 – if they are married filing separately and lived with their spouse at any time during the year
