With many college students home for the summer, we believe it is a good time to make you aware of potential tax planning opportunities that may be available for this age group.
Firstly, there is a $2,500 nonrefundable American Opportunity tax credit for a student enrolled at least on a half time basis for one academic period during the year. The student must be pursuing a program leading to a degree or other recognized education credential in an eligible school. The credit may only be claimed for four tax years and for the first four years of post-secondary education per eligible student on the tax return of either the parent or student. Generally the credit is taken on the return of the parents’ if both of the following conditions apply:
• The parents provide over half the support for the child and claim him/her as a dependent, noting the new exemption limits described below.
• The parents’ filing jointly adjusted gross income is under $180,000.
For tax years beginning in 2013, high-income taxpayers will have reduced personal and dependency exemptions. Specifically, the exemption is reduced by 2 percent for each $2,500 or portion of, which a taxpayer’s adjusted gross income (AGI) exceeds a threshold amount. The 2013 AGI threshold amounts, based upon filing status, are as follows:
• Married Filing Joint and Surviving Spouse: $300,000
• Head of Household: $275,000
• Single: $250,000
• Married Filing Separately: $150,000
In addition to the phase out of the personal and dependency exemptions, high income taxpayers also are not allowed any benefit from deductions or credits allowed for college education expenses paid. These benefits are completely phased out when adjusted gross income reaches $180,000 for taxpayers filing married filing jointly, and $90,000 for others.
If the parent is phased out from the dependency exemption or education credit, there may be an opportunity to capture some federal tax savings on the return of the student. The amount of eligible credit will depend on his or her income level as shown by the following guidelines:
• At $10,000 of adjusted gross income, the credit allowed is $393
• At $15,000 of adjusted gross income, the credit allowed is $893
• At $18,000 of adjusted gross income, the credit allowed is $1,343
• At $20,000 of adjusted gross income, the credit allowed is $1,643
• At $23,000 of adjusted gross income, the credit allowed is $2,093
• At $26,000 of adjusted gross income, the credit allowed is the maximum $2,500
To be eligible, the student may not take a dependency exemption. Taxpayers who take a dependency exemption generally claim to be paying over 50 percent of his or her support. Further information about this important distinction can be found on the IRS worksheet for determining support: http://apps.irs.gov/app/vita/content/globalmedia/worksheet_for_determining_support_17.pdf. In addition, the parent(s) will owe approximately $105 more to the state of Illinois for not taking the dependency exemption.
If the student does not have adequate income, and if the parent(s) own a business, one option could be to hire the student to perform legitimate work for a reasonable salary. Regardless of the education tax credit, further tax benefits may be realized if the child deposits this earned income into a retirement account such as a Roth IRA.
Please note that there are other education tax credits and strategies that may be available. The sophisticated software utilized by a CPA, or professional tax preparer, will be able to optimize which tax strategies are most beneficial for you.
• Judy Lynn is a CPA with Caufield & Flood in Crystal Lake. She can be reached at 815-455-9538 or via e-mail at JudyL@cfcpas.com or through the website CFCPAS.com.