Tax Planning for Parents of College Students: Help Clients Form a Strategy from the Code's Array of Options
As parents plan for their children's higher education, they may choose from an array of tax-favored savings vehicles and deductions and credits. Options include education savings plans, education credits, deduction of educational expenses, education savings bonds, education loans and other alternatives. No single option works best for everyone, but by reviewing the pros and cons of each alternative, families can choose a strategy that best meets their needs. Since planning for college education should start when children are young, CPA tax practitioners should offer these services to new parents as well as those with children currently in college. Yearly tax organizers should include questions about tax planning for college. When conducting yearend tax planning for parents of college students, CPAs should discuss related issues, including the dependency exemption on parents' returns during their children's college years. As the need for a college degree has increased, the cost of going to college has also increased. According to The College Board, for the 2011-2012 academic year, the average annual m-state tuition and fees at a public four-year college are $8,244, and the average total out-of-state tuition and fees are $20,770. The average annual tuition and fees at private nonprofit colleges are $28,500 (tinyurl.com/45joe2). These costs do not include room and board, books or supplies. According to The Project on Student Debt, the average college senior graduating in 2010 owed $25,250 in student loans (tinyurl.com/4yv5t7z). Families therefore have good reason to start saving toward these costs while their children are young. Savings vehicles include Sec. 529 plans, education savings bonds and Coverdell education savings accounts (Coverdell ESAs). All of these plans have their merits. (See the SEC's overview of Sec. 529 plans at tinyurl.com/d8ojwwg.) Families without savings can still take advantage of the following tax incentives once their children are in college. DEPENDENCY EXEMPTION FOR CHILDREN IN COLLEGE Most students have little or no tax liability while in school; therefore, it is usually beneficial for their parents or guardians to claim them as dependents. CPAs might start by reviewing with clients the tests that must be met for a qualifying child (Sec. 152). They are: Relationship. Naturally, a taxpayer's own children meet this test, but a child's descendant or a brother or sister or descendant of a brother or sister can also meet the definition of a qualifying child for the purpose of claiming a dependency exemption (Sec. 152(c)(2)). Residence. A qualifying child must have the same residence as the taxpayer for more than half of the year; however, a student living away from home while in college is considered to be living in the same residence as the parents (Regs. Sec. 1.152-1). Age. A qualifying child must be under age 19 or be a full-time student under age 24. For purposes of this test, a student must be enrolled in an educational organization, in what the college or university considers full-time attendance, during part or all of each of any five months in a calendar year (Sec. 152(f)(2)). Meeting this requirement can be difficult if the student does not sign up for a full load of classes or withdraws from some classes. Full-time attendance is defined by most universities as at least 12 semester hours. Both fall and spring semesters usually include at least parts of five months. Support. The student must not provide over half of his or her own support (Sec. 152(c)(1)(D)). The parents do not necessarily have to provide over half the support. College tuition and fees are included in the cost of support. If the parents pay these costs, the child may meet the support test even if the child pays most of his or her own living expenses. However, if a student pays the cost of tuition and fees or receives a student loan to pay them, that amount is counted as support provided by the student and can cause the child to fail the support test and thereby not qualify as a dependent. …