Families who have Modified Adjusted Gross Income in excess of the phase-out levels (Single-$90,000, or Married-$180,000) may not want to claim the student as a dependent. The student can claim the American Opportunity tax credit, provided the student’s Modified Adjusted Gross Income is not above the phase-out limits. Nonetheless, by not being claimed on the parents’ tax return, a student is not “independent” of the parents under the financial aid rules. The parents’ income and assets will still have to be listed on the student’s financial aid application; this tax planning strategy will not increase the student’s financial aid eligibility.

Specific Details

Ken, the parent, elects not to claim his daughter, Linda, as a dependent in his tax return, even though he is eligible to do so by reason of having provided over 50% of her support for the year. Linda is now eligible to claim the American Opportunity Credit on her federal income tax return and Ken is not allowed to claim any education credit. This same result occurs whether the parent or the child actually pays the qualified tuition. Assume that Linda has $5,000 of ordinary income during 2017 from wages, interest and dividends and $13,000 of long-term capital gain from stock sales and mutual fund distributions. Further, assume that there was at least $4,000 of tuition paid in 2017 which is eligible for the American Opportunity Credit. By declining to claim Linda’s exemption in the parental return, a $2,500 American Opportunity Credit can be utilized by Linda.

Potential Savings

A family can reduce its tax liability by $2,500 income taxes for the American Opportunity tax credit or $2,000 for the Lifetime Learning tax credit if the childs exemption is fully phased out on parents return and child has enough income tax liability to utilize the full credits.