The Internal Revenue Service (IRS) has a series of tests that determines whether or not you can claim a person as a dependent on your tax return. If your retired parents meet all four tests for a qualifying relative, you may claim them as dependents on your tax return. You can deduct an exemption, $3,650 as of the time of publication, for each dependent on your return.
You cannot claim your parents as dependents, even if they live with you, if they earn more than the exemption amount in gross income. As of the time of publication, the amount is $3,650. The IRS counts any form of income that can be taxed as gross income. If your parents receive distributions from an IRA or 401k plan, those count as income. Any income that comes from Social Security benefits, which are not taxed, does not count towards the gross income limit.
To claim your parents as dependents, you will need to provide at least 50 percent of their support. If your parents pay you rent to live in your home and contribute to the cost of groceries or utilities, you are most likely not supporting them, unless you can prove that they paid less than 50 percent of the cost to support themselves. One way to determine this is to look at the amount of income your parents contributed to rent and other costs versus how much you contributed. If they gave you $3,000 for rent and groceries but you contributed $4,000 to support them, then they pass the support test and may be claimable as dependents.
Your parents automatically pass the relationship test, provided they are your birth or adoptive parents or a step-parent. You cannot claim foster parents as dependent relatives. You can claim your in-laws, even if you and your spouse are divorced or your spouse has passed away. According to the IRS, as long as your parents meet the other three dependent tests, they do not even need to live with you for you to claim them as dependents.
If your parents live with you but your other siblings also help to support them, you will have to decide who can claim your parents as dependents. The sibling who claims your parents as dependents will have to contribute at least 10 percent of their support. She will also have to complete form 2120 and submit it with her tax return for the year. Form 2120 lists all who supported your parents during the year and includes waivers from the siblings who will not claim your parents as dependents. If you and your siblings support your parents equally, you can rotate who claims them yearly.