Monday, June 15, 2015

The Trouble with Children (Part 3 of 3): You can be a student, too!

(This is part 3 of a 3-part series of related blogs. Part 1 discussed child related credits; Part 2 discussed tax on children’s income.)

If you have (or are) a college student you may qualify for a Higher Education Tuition Credit. There are two different credits allowed -- depending on whether the student is in the first four years of college or pursuing additional education beyond four years, such as a Master’s degree. Of course, you may not take both credits for the same student in the same year.

The American Opportunity Tax Credit (AOTC, formerly the Hope credit) is allowed up to $2,500 per year for each eligible student. It is computed as 100% of the first $2,000 of qualified educational expenses, and 25% of the next $2,000. Qualified educational expenses generally include tuition, fees, and course materials, but not room and board, books (unless required for enrollment), student health fees or transportation. Expenses are reduced by any scholarships, grants, or employer provided educational assistance received by the student. A qualifying student can be the taxpayer, spouse, or dependent enrolled at least half-time in a degree program at a college or university. There is a 40% refundable portion of this credit. Note that the credit phases out when a single taxpayer’s adjusted gross income exceeds $80,000 ($160,000 for married filing joint) and is eliminated when AGI reaches $90,000 ($180,000 MFJ). Another important point is that the AOTC may not be taken by married taxpayers filing separate returns.

The Lifetime Learning Credit is allowed up to a maximum of $2,000 per taxpayer per year. It is computed as 20% of the first $10,000 of qualified educational expenses for all eligible students. Qualified expenses are the same as for the AOTC above, except materials and textbooks qualify also if they are required to be purchased from the university. Also like the AOTC, a qualifying student can be the taxpayer, spouse, or dependent, however, there is no requirement for at least half-time enrollment or a degree program. This credit is not refundable, and phases out between $55,000 and $65,000 of AGI for single taxpayers, or $110,000-$130,000 for married filing joint. As with the AOTC, taxpayers who are married filing separate returns cannot take this credit.

One item to consider is that if the student is a dependent child, the child can file a separate return and claim the credit themselves. Higher income taxpayers who would reach the AGI phaseout amounts can waive claiming the child as a dependent, allowing the child to file a separate return and claim the education credit, assuming they have enough tax liability for the credit to offset. The child is not eligible for the refundable portion of the AOTC. The child is also not entitled to claim a personal exemption on their own return.

Another consideration is coordination of these credits with educational savings accounts, such as Coverdell accounts, Qualified Tuition Programs, 529 plans, Series EE bonds, or educational IRAs. Please consult your tax advisor to determine the most favorable tax treatment of any qualified educational expenses.

Melissa Gregg

Monday, June 8, 2015

The Trouble with Children (part 2 of 3): I have to pay tax on what?!

(This is Part 2 of a 3-part series of related blogs. Part 1 discussed various tax credits for children and child care expenses.  Part 3 will discuss the credits available for higher education expenses for college students.)

There are important tax issues to consider if your child has earned income, like from an after school or summer job for example, or investment (unearned) income such as interest and dividends. Generally, if a child has earned income in excess of the standard deduction ($6,300 for 2015), unearned income over $1,050, total income exceeding the larger of $1,050 or the standard deduction for that year, or self-employment income of $400 or more, they must file their own return. If any tax has been withheld from their income, whether earned or unearned, they must file a return to get a refund of the tax withheld.

Tax on a child’s income is computed as for any other taxpayer, with limits on the personal exemption (because they are claimed as a dependent by someone else), and a lower standard deduction. Some children with investment income may be taxed on this income at their parents' highest marginal tax rate. This is known as the “kiddie tax”, and applies if the child is required to file a tax return, does not file a joint return for the year, and has investment income of more than $2,100 (for 2015). The child must also be under 18, under 19 and not provide more than half their support from earned income, or under 24, a full-time student, and not provide more than half their support from earned income.

If a child has only unearned income from interest and dividends, the parent may elect to include the child’s income on the parent’s return to avoid the kiddie tax. The election is made on Form 8814 and the child must meet the following requirements:

  • Is required to file a return and would be subject to the kiddie tax
  • Only has income from interest and dividends
  • Income is more than $1,050 and less than $10,500
  • Made no estimated tax payments, including overpayments from the prior year, and
  • Is not subject to backup withholding

The parents are then taxed on the child’s income in excess of $2,100, plus an additional tax of $105 if the child’s taxable income is more than $1,050, or 10% of taxable income under $1,050.

In short, if your child has earned or unearned income, you should consult your tax advisor to determine your filing requirements and limitations.  

Melissa Gregg

Tuesday, June 2, 2015

The Trouble with Children (part 1 of 3): Give me some credit(s)

(This is Part 1 of a 3-part series of related blogs.  See part 2 here.)

The trouble with children is that they grow up too fast. I realized this year that my oldest, who will be 17 this summer, will be ineligible for the Child Tax Credit for 2015! Soon he will be off to college, or work, and I will no longer get to claim a dependency exemption for him either! Luckily I have two other deductions – I mean children – that have several more years before they hit “adulthood”.

In all seriousness, there are tax issues that families with children face as those children grow. As I said above, when a child reaches age 17, they no longer qualify for the Child Tax Credit. When a child turns 19, they are considered an adult, and cannot be claimed as a dependent unless they are a full-time student. A college student age 19-23 can still be claimed as a dependent if they otherwise meet the requirements to be a dependent. Individuals who are separated or divorced must also be careful that only one of them claims a child as a dependent for a given year.

The Child Tax Credit mentioned above is available for qualifying dependent children up to age 17. The credit is $1,000 per child, but is phased out as a taxpayer’s adjusted gross income increases. The credit is generally non-refundable , but there is a refundable portion of the credit, called the additional Child Tax Credit, through December 31, 2017. You may want to consult a tax advisor for more information, since the tax code is too complex to explain in a short blog post.

Another issue to consider is the Child & Dependent Care Credit. This non-refundable credit is allowed for only a portion of qualifying childcare expenses paid to allow both the taxpayer and the taxpayer’s spouse to work. Generally, a taxpayer must have earned income and employment-related dependent care expenses, and the child must be a qualifying dependent under age 13. The maximum amount of expenses allowed for the credit is $3,000 per child, up to $6,000 total. Any employer-provided dependent care assistance is subtracted from this amount. The credit amount ranges from 20% to 35% of the net expenses, depending on the taxpayer’s adjusted gross income. Qualifying expenses include payments made to a care provider inside or outside the home, even if it’s a relative (like your mom or sister). This does not include your 18 year old child watching your 5 year old after school, since they are both your dependents. Qualifying expenses do include summer day camps, but not summer school or tutoring programs. Also remember that the credit is for expenses paid so that the taxpayers can work – it generally doesn’t apply if one parent is a stay-at-home mom or dad. As with everything there are exceptions, so be sure to consult your tax advisor to see if you qualify.

Part 2 will explore the requirements for filing if your child has earned and/or unearned income, so stay tuned.

Melissa Gregg