You can claim your niece as a dependent on your income tax return if she fits the Internal Revenue Service's definition of either a "qualifying child" or a "qualifying relative." The IRS has several tests to determine whether she qualifies under either of these definitions. She must meet all the tests for a definition in order for you to claim her.
Qualifying Child Tests
The IRS applies five tests to determine whether someone is your qualifying child. The first of these tests is the relationship test. Only certain relatives are eligible to be a qualifying child. Nieces and nephews are among those who are eligible, so this test shouldn't be a problem. However, your niece must also pass the IRS's age, residency, support and "joint return" tests.
To pass the age test, your niece must be 18 or younger at the end of the tax year for which you want to claim her as a dependent. If she's a full-time student, she can be 23 or younger. In either case, she must also be younger than you. If she's older than you, then she can't be your qualifying child, no matter what other tests she meets. To pass the residency test, she must have lived with you for more than half the year. "Living with you" means that your home was her permanent residence. If she was away at school, for example, she can still be considered to have been living with you, if your home was the place she planned to return to. To pass the support test, your niece must not have provided more than half of her own financial support during the year. Finally, if your niece is married but still meets the other tests, you can claim her as a dependent so long as she doesn't file a joint tax return with her spouse.
Qualifying Relative Tests
If your niece doesn't meet all of the tests to be a qualifying child, she may still be your qualifying relative, which would allow you to claim her as a dependent. The IRS has four tests to determine whether she's a qualifying relative. The first is the "not a qualifying child" test. This simply means that you can't claim her as a qualifying relative if she meets the test to be a qualifying child. The second test is the relationship or household test. Under IRS rules, some relatives must live in your home you for you to claim them as dependents, while others do not. Nieces and nephews do not have to live with you, so this test is not a problem. The other two tests are the gross-income and support tests.
To pass the gross income test, your niece cannot have made more than a certain amount of money during the tax year for which you want to claim her. As of 2010, that cutoff point was $3,650. If she had that much income, she can't be your qualifying relative no matter what other tests she meets. To pass the support test, you must have provided more than half of your niece's financial support for the year. Note the difference between the support tests for a qualifying child and a qualifying relative. With a qualifying child, it doesn't matter who provides the child's support, just as long as she doesn't provide most of it herself. With a qualifying relative, you have to provide most of her support.