Understandably, many parents get in the habit of claiming their children as dependents on their federal tax returns. While you may do so as long as your child is either under age 19 (if a non-student) or under age 24 (if a student), there is a compelling reason to refrain from claiming your child as a dependent.
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 post-secondary education. The Lifetime Learning credit provides up to $2,000 in relief to those eligible. Just know that if you plan on taking advantage of the credit, you can’t claim both credits in the same year for the same student.
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) above $80,000 (for single filers) or $160,000 (for married couples filing jointly). Similarly, eligibility for the Lifetime Learning credit begins to phase out for taxpayers with MAGIs above $55,000 (for singles) or $110,000 (for joint filers).
Qualifying for the Credits
If your income disqualifies you from claiming these credits, it’s likely that your child’s income probably doesn’t disqualify him or her. If this is the case, your child may be able to report payment of education expenses for tax purposes and then claim one of the credits. However, they will only be able to do this if no one has claimed him or her as a dependent.
In this scenario, the child’s tax benefit typically outweighs the value of the dependency exemption to the parents. For one, a credit reduces taxes dollar-for-dollar, while an exemption reduces only the amount of taxable income. Secondly, 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 (for singles) and $309,900 (for joint filers).
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 one of these tax credits. However, if your exemption isn’t phased out or is only partially phased out, the decision becomes trickier.
Because multiple factors can affect whether or not you should claim your children as dependents, be sure to check with your Untracht Early advisor to help you make the proper determination.