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 Tax Credit and the Lifetime Learning credit. The American Opportunity Tax 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 “phase-outs” that limit eligibility for higher-income taxpayers. For example, for 2020, 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 $59,000 (single) or $118,000 (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. This credit can then be used to offset some of the tax that the child may have on their return, but is not refundable.
Under this scenario, the child’s tax benefit typically outweighs the value of the child tax credit for the parents. Why? Because an income-based phase-out may reduce or eliminate the benefit of the child tax credit even if you did claim your child as a dependent. For 2020, the phase-out starting points for the child tax credit are adjusted gross incomes of $200,000 (singles) and $400,000 (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 child tax credit isn’t phased out or is only partially phased out, the decision becomes trickier. We can help you make the right call.