Thursday, June 9, 2016

Smart Tax Planning Strategies for Graduation Year

FROM http://www.huffingtonpost.com/

June isn’t just for weddings; in many cases, it is for another life change that comes with possible large tax return implications - graduation. Graduation is a time of changes; it begins with looking forward - to your child’s new adventures and their entry into the “real world” and then planning for them and possibly for you.
When it comes to higher education and taxes, planning is important because there are many credits and deductions and various qualifications for each. It is important to know what steps to take to achieve the most beneficial tax situation for your family. As with any other life change, there are a number of considerations that come into play. Though you may have contributed a lot to your graduate’s support this year, you may actually end up with higher taxes if you don’t plan carefully. Furthermore, not only should you plan carefully for this year, but for next year as well

Probably the most important thing to determine in the year of graduation is whether your graduate is still your dependent. While it may feel like you are still supporting your kids, the IRS requires that your child not be paying more than half of their own expenses for you to claim them. You have to add up all the money they spend as well as the money you and others spend. Unfortunately, it is not unusual in the year a child graduates to lose their dependent exemption even though you are still spending a lot of money on them. Losing the dependent exemption means a $4,000 increase in taxable income AND not being able to claim an education credit for any of the college tuition you paid during the year. And, if you qualify to claim your child as a dependent, but don’t - they cannot claim their own exemption!
You may also lose your Head of Household filing status when you lose your dependent. The rules require you to have a dependent child or other dependent to claim the Head of Household filing status. If your graduate was your qualifying dependent, your filing status would change to Single or Married Filing Separately. This can result in much higher taxes because your standard deduction decreases and your taxes increase. Add to that the loss of an exemption, a change in filing status, AND the loss of any related Education Credits, the loss of any Earned Income Tax Credit you may have been eligible for based on your graduate and you can see you can suffer some pretty dramatic changes in your tax life when your child graduates.
And that empty nest you may or may not been looking forward to, well if your graduate moves back home because they can’t afford to live on their own, you may not be able to claim them next year either. The rules concerning our children specifically change once they are over 18 and are no longer a student, or once they turn 24. You can only claim them as a dependent if their total income for the year is less than $4,000, they live with you, and you provide more than half their support once they turn 24.
Some good news, you are still eligible for the interest deduction on student loans, which is currently up to $2,500 a year, even if you don’t itemize deductions or claim the graduate as a dependent. The student loan must be in your name and have been taken out when your child was still your dependent, you can claim the interest you paid to reduce your taxable income.
As has been said before, life changes can impact a tax return even more than tax law changes. Having a dependent graduate is exactly one of those life changes and most of those changes aren’t good - things like lowering the size of your refund or increasing the amount you owe.
Once all the pomp and circumstance is over, parents and the graduate are left coping with mixed emotions. Pride and joy about completion of a college career and the stress and fear of the question “what’s next?” Generally, it is a best practice to plan and review your tax situation, but it is even more important when you are facing life changes. The planning part can be overwhelming and you may want to speak to your tax pro or review the detailed information about education tax benefits, on the IRS Tax Benefits for Education information center. Having a tax plan and using sound strategies not only sets the graduate up with a great habit, it will teach them how to keep more of their money come tax time.
Another best practice is a mid-year tax assessment and summer is the perfect time to do so. For now, celebrate graduation and the milestone it is, and next week check out what you should consider during a mid-year tax assessment.