Many of my clients find the tax breaks for children confusing, and understandably so. There’s the child tax credit, the dependent exemption for each child and also a variety of special tax breaks for college. Each of these tax benefits has its own eligibility rules and income-based phase-outs.
First for the basics: exemptions and credits are not the same thing. An exemption is similar to a deduction in that it reduces taxable income. A credit directly reduces your tax, dollar for dollar. For 2015, the dependent exemption is worth $4,000. If you are in the 25% tax bracket with one child, you can claim a $4,000 exemption for him or her. That reduces your taxable income by $4,000, which reduces your tax by $1,000. You may also qualify for a child tax credit of $1,000, which will directly reduce your tax by another $1,000. Since the exemption is adjusted for inflation, the value of the exemption increases annually. The child tax credit (absent legislative changes) is permanently $1,000 per child.
As a taxpayer, you can claim an exemption for yourself unless you qualify as a dependent of another taxpayer. If you qualify as a dependent of another taxpayer, you cannot claim an exemption for yourself even if the person who could claim you as a dependent doesn’t do so or gets no tax benefit from claiming you. (That’s important to remember when we get to college students.)
You can also claim one exemption for each of your dependents. It’s understandable that parents want to continue claiming their children for as long as possible, especially during those expensive college years. While most college students still qualify as dependents (because parents provide a majority of their support), as the parents’ income increases the value of dependent exemptions decreases and may be lost entirely. Thus it is sometimes better for parents to forego claiming college students as dependents to allow the student to take advantage of tax credits for higher education, as I’ll explain later.
The $4,000 exemption phases out for high-income taxpayers. For a married couple filing jointly, the phase-out begins at $309,900 of Adjusted Gross Income (AGI) and exemptions are phased out entirely at $432,400. For single filers, phase-out begins at $258,250 and ends at $380,750. In addition, personal exemptions aren’t allowed in the calculation of the Alternative Minimum Tax.
Child Tax Credit
The child tax credit is generally $1,000 per qualified child under the age of 17. The definition of who is a qualified child for the child tax credit is generally the same as it is for the dependency exemption. (With the exception, of course, of the age restriction in the child tax credit.)
The child tax credit is normally non-refundable, meaning it’s limited to your regular tax liability plus alternative minimum tax, although a portion of the child tax credit may be refundable for certain taxpayers. This is known as the Additional Child Tax Credit and Schedule 8812 is used to determine whether you qualify and to calculate the amount of the credit.
The child tax credit is also subject to a phase-out based on income. The upper limit of the phase-out depends on the number of children you have. For a married couple filing jointly, the phase-out begins with an AGI of $110,000. The credit is completely phased out at $129,001 for one child, $149,001 for two children, $169,001 for three children, $189,001 for four children and $209,001 for five for more children.
Strategy For High-Income Taxpayers
If your income is high enough to lose out on the dependent exemption for a child attending college, your family may benefit from opting not to claim your college student as a dependent.
By this point, your child is over the age of 17, so the child tax credit is not available. Depending on your AGI, you may have lost all or part of the exemption for that child as well. If you’ve lost the dependent exemption, your AGI is most certainly too high to take advantage of tax benefits for higher education.
The tax credits and deduction for higher education expenses have much lower AGI phase-out limits than the personal exemption. For example, the American Opportunity Credit for undergraduates is phased out between $80,000 to $90,000 for a single filer and $160,000 to $180,000 for a married couple filing jointly. The phase-outs for the Lifetime Learning Credit and the Tuition and Fees Deduction are even lower.
If your college student works a part-time job while in school or has enough investment income to necessitate filing a return, it may be worth the additional work to compare claiming the child as a dependent versus foregoing the exemption to allow the child to claim an education credit on his or her own return. For 2015, the American Opportunity Credit for undergraduates is worth up to $2,500 per student a year. While 40% of that credit is refundable, meaning a taxpayer can receive a refund of up to $1,000 even if he doesn’t owe any tax, a child who qualifies as a dependent (even if you don’t claim him as one) can’t claim the refundable portion. That means the child needs taxable income to benefit from the AOTC.
Remember, though, that if your child was eligible to be claimed as a dependent on your return and you chose not to claim him, the child cannot claim a personal exemption for himself. To review: if your child is really your dependent (because you provide a majority of his support), but you don’t claim him as a dependent, he still can’t claim his own exemption, but he may be able to make use of the college tax credit. It’s complicated, but fortunately, with most tax software, claiming your child as a dependent (or not) involves checking a box and seeing how your tax liability changes. That’s for this year. If you’ve got a high income and want to do some planning to maximize the AOTC when your kids get to college, check out this article by college finance expert Troy Onink.)
This article was written by Janet Berry-Johnson from Forbes and was legally licensed through the NewsCred publisher network.
The strategies mentioned in this article will often have tax and legal consequences; therefore, it is important to bear in mind that First Republic does not provide tax or legal advice. This information is provided to you “AS IS”, does not constitute legal advice, is governed by our Terms and Conditions of Use, and we are not acting as your attorney. We make no claims, promises or guarantees about the accuracy, completeness, or adequacy of the information contained here. Clients’ tax and legal affairs are their own responsibility – Clients should consult their own attorneys or other tax advisors in order to understand the tax and legal consequences of any strategies mentioned in this article.
The views of the author of this article do not necessarily represent the views of First Republic Bank.