College Planning with Tax Strategies: Part 1 – Should I claim my child as a dependent and other tax considerations for college

By Joe Messinger, CFP®

November 12, 2016

3 min READ

Higher income families that attend the high school financial aid night often walk away with nothing but frustration and feeling like it was a waste of time. This College Planning with Tax Strategies blog series is for you.

The reality is that high-income earners and many business owners will probably not be eligible for financial aid when their child is ready for college. Their income is simply too high to qualify for need based aid.

Here is the good news, once you know that you are not going to receive need-based aid you can shift your focus to other strategies to cut your college cost. The first thing to focus on is finding colleges who offer aid based on the merit of your talented student.

Another place where you can realize savings is by taking a closer look at tax strategies that are often overlooked to cut the cost of college.

Many families fall back on the standard tax credits and deductions…mortgage interest, per child deduction, etc. but never stop to think if the standard methods are the right ones for them.

If a family earns more than $200,000, they are likely subject to the Alternative Minimum Tax (AMT) and whether or not they have children or students in college will not affect their tax amount due. So the question becomes, if you are not going to get a tax benefit for claiming your student, should you claim them as a dependent?

Maybe not. Working closely with your tax professional to determine what is best for your family’s situation is critical. It is important to at least consider utilizing your child’s tax capacity —the lower tax bracket and ability to access education credits.

Removing the student as a dependent from the parents’ taxes may provide the student with access to education credits the parents were not able to qualify for because of their higher income and cut the family’s total tax bill. Such as:

• Tuition & Fees discount – up to $4,000 – Unavailable to married couple filing jointly with more than $160,000 Modified Adjusted Gross Income (MAGI)
• American Opportunity Tax Credit – $2,500 – Unavailable over $180,000 MAGI
• Liftetime Learning Credit – $2,000 – Unavailable over $120,000 MAGI

How does a student qualify for their own dependency deduction? A full-time student under 24 years old can claim dependency on their own if they provide over 50% of their own financial support.

Most students don’t earn enough from working to meet that 50% mark; however, financial support can include not only paid salary but also investment income and appreciated assets gifted from the parent or grandparent to the student.

The student that sells those appreciated assets will also avoid capital gains tax on the first $2,100 of gain. Capital gains above that amount can make the student subject to the “kiddie tax” at their parent’s tax rate. (More on how kiddie tax works.) However, the education credits may offset any additional tax due and still be an overall tax savings for the family.  So the student avoided capital gains tax and uses that money to pay for their expenses thus crossing over that 50% line and meeting the “support test” requirement and can claim a portion of the education tax credits. Pretty cool!

The tax code is complicated. We are attempting to bring up some items in an easy to understand manner to make you question whether the old standby way of filing your taxes is the correct one. Always consult with your tax professional to determine what is best for your unique situation. Tune in to our next blog and learn how business owners can save thousands in taxes every year by shifting income and even make tuition tax deductible!

Business owner? Check out our Part 2 blog on special tax considerations for you.