Understandably, many parents get in the habit of claiming their children as dependents
on their federal tax returns. You generally may do so as long as your child is either
under age 19 (nonstudents) or under age 24 (students). But there is a reason to not
claim your child as a dependent - and it has everything to do with higher education.
Credits and phaseouts
The two primary college-funding tax credits available are the American Opportunity
credit and the Lifetime Learning credit. Thanks to recently passed legislation, the
American Opportunity credit now permanently allows eligible taxpayers to take an
annual credit of up to $2,500 for the first four years of postsecondary education.
Meanwhile, the Lifetime Learning credit provides up to $2,000 in relief to those
eligible. (You can't claim both credits in the same year for the same student.)
But these credits are subject to "phaseouts" that limit eligibility for higher-income
taxpayers. For example, for 2015, eligibility for the American Opportunity credit
begins to phase out for taxpayers with modified adjusted gross incomes (MAGIs) beyond
$80,000 (single filers) or $160,000 (married couples filing jointly). Similarly,
eligibility for the Lifetime Learning Credit begins to phase out for taxpayers with
MAGIs beyond $55,000 (singles) or $110,000 (joint filers).
If your income disqualifies you from claiming these credits, your child's income
probably doesn't disqualify him or her. Therefore, your child may be able to report
payment of education expenses for tax purposes and then claim one of the credits -
but only if you don't claim him or her as a dependent.
Under this scenario, the child's tax benefit typically outweighs the value of the
dependency exemption to the parents. Why? First, a credit reduces taxes
dollar-for-dollar, while an exemption reduces only the amount of taxable income.
Second, an income-based phaseout may reduce or eliminate the benefit of the exemption
even if you did claim your child as a dependent. For 2015, the phaseout starting
points for the exemption are adjusted gross incomes of $258,250 (singles) and
$309,900 (joint filers).
The right call
If your dependency exemption is phased out, it will probably make sense not to claim
your child as a dependent so he or she can grab a tax credit. But if your exemption
isn't phased out or is only partially phased out, the decision becomes trickier. We
can help you make the right call.
This publication is distributed with the understanding that the author, publisher and
distributor are not rendering legal, accounting or other professional advice or
opinions on specific facts or matters, and, accordingly, assume no liability
whatsoever in connection with its use. The information contained in this newsletter
was not intended or written to be used and cannot be used for the purpose of (1)
avoiding tax-related penalties prescribed by the Internal Revenue Code or (2)
promoting or marketing any tax-related matter addressed herein. © 2016