Tax Planning for Graduating College Senior headed to Graduate School

Parents Forum
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D2 will be graduating from college in May. She will be 22 early in 2017. Her spring tuition was billed in December, and the school’s tuition prepayment plan paid in December thus no AOTC in 2017. We will be getting some credit in January since she only needs 7 credits and that payment will go to us. So she will not be a full-time student from January through August, though will be more than a half-time student. Claiming her has no benefit to us since our exemptions are phased out, so we have not been claiming her for several years.

Basically, her undergraduate institution takes the payment from the plan at the billing date of the tuition and has been sending her 1098-T’s to that effect. We expect her to be eligible for a non-refundable AOTC in 2016 to wipe out any income tax she might have incurred due to her Summer REU and the income from being a TA. She will not claim an exemption in 2016 since we clearly provide more than half of her support for 2016.

We are trying to do optimal tax planning by potentially giving her a gift in 2016 so that she avoids being our dependent for 2017 and

  1. Be in a position to avoid the 2017 kiddie tax on any potential fellowships she might get for graduate school
  2. Allow her to claim that she provided more than 50% of her own support

I struggle a little with the support test. I can plug the numbers in, but don’t have a lot of insight.

She lives in an apartment and will pay her own rent and utilities from her checking account. She does that now.
She will have her own credit card and will use it to purchase groceries and clothing. She will pay the bills with her own funds.

She is on our medical plan. Would her medical expenses be the difference between the husband/wife vs family plan plus out of pocket expenses? I guess her health insurance premiums are on us, and when she gets to graduate school may elect the school’s health insurance depending on the coverage.

She drives a car that technically I own. I understand the cost of operating the car is part of support, so the insurance is funds we supply, though I’ve already paid it for the year through September. She pays her own gas.

We were planning on buying her a nice used car for her graduation in the 10K-15K range which she would own, though by then we would know the form of her graduate support, and we can just postpone this until January if it makes sense.

Also, since she wouldn’t have graduated from undergraduate at the start of 2017, I read that she could potentially use AOTC from her first semester of graduate school and just simply consider $4000 of the tuition a taxable stipend? Clearly the $2500 tax credit will be worth more than the income tax on the $4000. I have to do more research on this one.

Just wondering what other’s experience with a similar scenario has been or if anyone has thought about this.

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@Madison85 or @BelknapPoint

Why would it matter if the gift was given in 2016 or 2017? Gifts are not “income”. Seems to me that a gift would have nothing to do with being a dependent…or not…in either tax year.

3

But a gift in 2016 allows her to have a bigger bank account balance at the start of 2017 so that anything drawn on it is “paying her own support”.

I just read somewhere else, that taxable scholarships are excluded from support. This is really bad.

Also, from Pub 970, Tax Benefits for Education, AOTC can’t be used for grad school if a tax-free scholarship covered the tuition. More bad.

LOL! It might be the case that having her borrow money while she’s 22 and 23 and paying interest on it would come out cheaper than having her graduate stipends taxed at our rates. Because she will be a graduate student at the start of the 2017-2018 year, she will be independent from FAFSA’s point of view. Loans do count as student support. She can just save the fellowship money and pay off the loan when she’s 24.

4

You should check this out with the IRS but here’s an idea - If she has and will continue to live in her own apartment(s) and establishes legal residency there, then even if she is a full time student and you provide more than 50% of her support, you will not be able to claim her as a dependent for tax purposes because she doesn’t live with you (and her absence from your house is not temporary).

She can then claim herself as an exemption on her own tax return.

Remember that the portions of a graduate school stipend that are not earmarked for tuition/fees count as taxable income (I think). They would count as a means of support too.

I don’t know if this completely solves your problem, but it’s a start. Why is it important for her to be able to claim that she provides more than 50% of her own support?

As a practical matter, I really really doubt the IRS is going to audit a full-time graduate student to determine whether she is independent if she says she is as long as she is earning a few thousand dollars of income. They are usually far more worried about the reverse - i.e. parents inappropriately claiming an adult child as a dependent or the same person being claimed as an exemption on two different returns.

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Also be aware that taxes are generally not withheld from grad student stipends, so she may well owe taxes for TY 2017 and beyond and will need to consider quarterly payments of estimated tax.

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That’s not the issue. I don’t want to claim her. I want her fellowship income to be taxed at her rates and not at my rates via the kiddie tax.

Only if she provides half of her own support

Only the earned income parts. My understanding that a taxable fellowship such as NSF is not considered earned income and if she’s not independent will be subject to the kiddie tax.

That’s hardly the point. Tax avoidance is good. Tax evasion is bad. This is true at any age.

So it looks like Stafford loans are capped at the cost of attendance after subtracting other aid. So this plan may be faulty.

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@ClassicRockerDad -
I totally get that you don’t want to claim her.

You cannot claim her if she does not live with you. That is what you want. So just make sure she doesn’t live with you. Since she in fact lives in her own apartment and (I assume) isn’t going to return home to live after graduate school, just make sure she gets a drivers license, etc. so that she establishes legal residency and so her documentation is in order.

Go to the IRS website and read the rules very carefully about when a person can claim themselves as an exemption and can get the full standard deduction. The 50% test is just one prong of the test. I think I am right about this, but please confirm it for yourself.

This should reduce your child’s taxes since she can now claim the exemption and the standard deduction. Doesn’t help with the kiddie tax issue though.

I think you are 1/2 right about this. The intent of the kiddie tax was to go after investment income, not fellowships. However, it looks like fellowships are caught up in this rule even if that wasn’t the intent. I didn’t know that until now.

TA ships and RA ships would not be subject to kiddie tax since they usually are considered earned. Only fellowship stipends are subject to kiddie tax.

However, if I am reading the rules right then even if she provides more than 50% of her own support you will still have to pay kiddie tax on fellowship stipends. Being dependent or independent doesn’t matter. Your scheme to give her money in 2016 that she can live off of in later years doesn’t help. You will have to pay the kiddie tax until she is over 24 or no longer a full-time student. Not to pay it would be tax evasion. So pay it.

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@al2simon This is actually tremendously helpful.

The relevant facts are

  • She will not be a full-time student Spring 2017. She only needs a few credits to graduate - more than half time, but less than full-time. If her graduate program starts in September, she will not have been a full-time student for part of 5 months, so will not be considered a full-time student for the age test, whereas if her program starts on Aug 31, she will be a full-time student
  • She must live with us for less than 1/2 the year. Since she surely won’t live with us from Aug 1 on, she can decide April 1 whether to change her residency from Mass to the state where her undergraduate school is to get 7 months of not living with us. If ends up going to UMASS, than she can keep her MASS residency, but UMASS starts in September and she won’t be considered a full-time student because she won’t have 5 months. If she goes to a school that starts in August, she can change her residency on April 1 and will still have at least 7 months of not living with us.

So we can surely arrange things to be unable to claim her.

Now for the kiddie tax, from Thomson-Reuters
https://tax.thomsonreuters.com/media-resources/news-media-resources/checkpoint-news/daily-newsstand/strategies-for-dealing-with-the-kiddie-tax-part-i/

The kiddie tax rules apply to the income of any child who:

1. (a) is under age 18, regardless of whether his earned income equals more than one-half of his support; or (b) turns 18, or if a full-time student turns 19-23, before the end of the applicable year, and the child’s earned income for the tax year doesn’t exceed one-half of his support; (Code Sec. 1(g)(2)(A))

Her earned income must exceed one-half of her support for the kiddie tax to not-apply. This is very bad. Actually, it’s quite possible that even if she goes to a school that starts in September 2017, which would save her from the kiddie tax on a fellowship in 2017, she will surely be a full-time student in 2018 and still only be 23.

So for example in 2018, (assuming today’s tax rate, though I suspect it will go down), the kiddie tax on a $30,000 stipend would be (39.6%-15%)*3000= $7380.

Ouch!

So @al2simon, you read is incredibly insightful and unfortunately incredibly correct. Thank you! She should try to get a TA or RA instead of a fellowship until she’s 24.

We could still give her enough money in 2016 so that she could pass the support test for the purpose of an exemption. That test counts her bank balance on Jan 1 as her own money.

9

I am sorry that your daughter is caught in this kiddie trap tax. Like I said, that was not the intent of it. It was to stop parents from trying to shelter investment income in their kids’ name.

This is a pretty esoteric application of the tax code. It wouldn’t surprise me if a lot of graduate students and their families are not in compliance. However, I would call some schools up or talk to a specialist tax advisor before finalizing any plans. Maybe there is a legal way around it.

Of course, one legal way around the kiddie tax is for her to get married :slight_smile:

This might not be wise. It seems very hasty to tell your daughter not to try for fellowships. A lot of fellowships are only awarded in the last year of undergrad or the first year of grad. Fellowships are often better than TA or RA -ships. In addition to being more prestigious (which can be a plus in graduate school and on the job market), a fellowship can make it easier to get your first choice of Ph.D. advisors since having a fellowship makes a student “free” to the advisor. It also relieves students from having to spend time teaching and allows them to spend more time on their coursework / research. Even an extra $7,380 of tax for a year or two might be worth paying for this … it all depends.

If your daughter is lucky enough to win a fellowship like an NSF, these fellowships often allow you to “defer” them for a year or two (until she is past 24). She could defer it for a year and ask the department to give her a TA-ship instead for her 1st year.

I’m still not sure that this is necessary because you can arrange things so that she doesn’t live with you, but you know better than I. Of course, even if it’s not necessary I am sure your daughter wouldn’t mind getting some extra money from her loving parents :slight_smile:

Anyway, although I am throwing out some angles to look into, there is a lot more research to be done.

10

@al2simon, you are correct again. As long as we can’t claim her, she gets an exemption, so the gift before the end of the year is unnecessary, and of course the advice to first win then defer fellowships is a good one too. Thanks again.

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The AOTC can never be used for graduate school.