College students combine many sources of funds to pay for their education, including personal savings, family savings, income from jobs, scholarships and/or student loans. As the percentage of funds from the student’s sources increases, parents risk losing the student as a dependent on their tax return. Not only do the parents lose the exemption deduction, but they also lose available higher education tax benefits (Hope scholarship, American opportunity and lifetime learning credits, and tuition deduction). The combined effects can add up to a significant amount.
Taxpayers and tax professionals need to carefully evaluate the impact that the sources of college funding can have on the net tax and financial position of the family unit. Blindly assuming that a student qualifies as a dependent on the parents’ tax return can result in noncompliance with tax law and can have other financial implications. With some preparation, tax professionals can plan for the dependency exemption issue and maximize the family’s net tax savings.
WHAT ARE THE REQUIREMENTS TO REMAIN A DEPENDENT?
A dependent is defined under IRC § 152(a) as either a qualifying child or a qualifying relative. To be a qualifying child under section 152(c), a student must meet four tests:
Relationship. The child must be the taxpayer’s child or stepchild (whether by blood or adoption), foster child, sibling or stepsibling, or a descendant of any of them.
Age. The child must be under age 19 or a full-time student under age 24 at the end of the year. To be considered a full-time student, the child must be enrolled for the number of hours or courses the school considers to be full time and must be a student for at least five months during the year.
Residency. The child must live with the taxpayer for more than one-half of the year. The child is considered to live with the taxpayer while he or she is temporarily away from home due to education, illness, business, vacation or military service.
Support. The student cannot have provided more than onehalf of his or her own support.
If a student meets these four tests, the parents may claim the exemption if the student meets the general dependency tests under section 152(b). The general tests include:
Marital status. If married, the student did not file a joint tax return for the year, unless the return is filed only to claim a tax refund and no tax liability would exist for either spouse.
Citizen or resident. The student must be either a U.S. citizen, resident or national, or a resident of Canada or Mexico.
Parents and tax professionals cannot assume that a college student will remain a dependent of the parent until he or she graduates. With the variety of funding sources students use to pay for the ever-increasing cost of higher education, many are likely to provide more than one-half of their support at some point during their college years.
The implications of a student no longer qualifying as a dependent extend beyond the parents’ and student’s tax returns to include, for example, benefits provided through the parents’ employers. Taxpayers and tax professionals must approach the dependency issue with prudent planning.
For a detailed discussion of the issues in this area, see “Dependency Exemption Issues for College Students,” by Nancy B. Nichols, CPA, Ph.D.; Susan Q. Ferguson, CPA, MSA; and William M. VanDenburgh, Ph.D., in the August 2010 issue of The Tax Adviser.
—Alistair M. Nevius, editor-in-chief
The Tax Adviser
The Tax Adviser is the AICPA’s monthly journal of tax planning, trends and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or e-mail taxsection@aicpa.org for a subscription to the magazine or to become a member of the Tax Section.
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