Graduation season brings more than caps and gowns—it creates pivotal moments that can significantly impact your clients' tax situations. As families transition through high school graduations, leading to college or college graduates entering the workforce, understanding these changes positions you as an invaluable advisor who sees beyond the current year's return.
The Dependency Decision Point
The most immediate question facing families is whether parents can still claim their graduate as a dependent. For college-bound students, parents typically maintain dependency status if the student is under 24, enrolled full-time for at least five months, doesn't provide more than half their own support, and lives at home for more than half the year (excluding temporary school absences).
However, college graduates entering the workforce often break these dependency chains quickly. Once they earn over $5,200 annually or provide more than half their own support, the dependency relationship ends. This shift affects not just the dependency exemption but also determines who can claim valuable education credits.
Education Credits: Timing Is Everything
The American Opportunity Tax Credit offers up to $2,500 per student for the first four years of undergraduate education, with 40% being refundable. Parents in higher tax brackets typically benefit more from claiming this credit than their newly graduated children. However, if parents' modified adjusted gross income exceeds $180,000 (married filing jointly) or $90,000 (single), the credit phases out completely, making it beneficial for the student to claim it instead.
The Lifetime Learning Credit provides up to $2,000 annually with no yearly limit, making it valuable for graduate school or continuing education. Unlike the American Opportunity Credit, it's not refundable and has lower income thresholds for phaseout.
Strategic planning involves coordinating who claims the credit to maximize the family's overall tax benefit. Sometimes, splitting education expenses between family members or timing payments across tax years can optimize results.
Student Loan Interest Considerations
New graduates with student loans can deduct up to $2,500 in student loan interest annually, but only if they're not claimed as dependents. This creates another factor in the dependency decision. The deduction phases out for single filers with modified adjusted gross income between $75,000 and $100,000, making early career timing crucial.
Parents cannot deduct student loan interest unless the loan is in their name, even if they make payments on their child's behalf. This often surprises families and represents a planning opportunity for future education funding.
Scholarship and Financial Aid Tax Implications
Scholarships covering tuition, fees, and required course materials are generally tax-free. However, amounts used for room, board, or other living expenses become taxable income to the student. This can affect dependency status if scholarship money covers living expenses, as it counts as support provided by the student.
Work-study income and graduate assistantships are considered taxable wages, which may impact both dependency status and eligibility for various tax credits and deductions.
Health Insurance Transitions
While not directly tax-related, remind clients that dependent children can remain on parents' health insurance until age 26, regardless of student status, marriage, or employment. However, if the new graduate has access to employer coverage, coordinate to ensure optimal coverage and tax efficiency.
Planning Opportunities
Present these transitions as opportunities for planning rather than complications. Help families model different scenarios, such as claiming dependency versus independence, timing education expenses, and coordinating multiple children's education costs. Your expertise in navigating these decisions demonstrates the value of year-round tax planning, which extends beyond simple compliance, thereby enhancing your ability to charge for advisory services beyond tax preparation fees.
Consider establishing mid-year check-ins with clients who have college-age children. These conversations can uncover planning opportunities and reinforce your role as a strategic advisor. Graduation season isn't just about celebrating achievements; it's about positioning families for optimal tax outcomes as their circumstances evolve.
Christine Gervais is a licensed CPA, using her skills to help businesses grow and achieve their fullest potential. Christine has a Master’s degree in accounting from Southern New Hampshire University in addition to holding her CPA license for over a decade. Notably, Christine is a nationally recognized speaker providing education to other CPAs on how to best serve clients as well as instruction on a wide variety of topics for business owners on how to maximize success. Christine prides herself on the value she can bring to clients with her extensive tax knowledge and provides strategic, forward-thinking financial strategies to help clients grow. When not behind her desk, you can find Christine spending quality time with her daughter and stepson or tending to the family’s excessively loved farm animals.
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