By Ashlee Ogrzewalla, CFP®, CFDA®, Vice President and Manager of Financial Planning & Marketing
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Tax season can feel like navigating a maze, especially when balancing multiple incomes, dependents and household expenses. However, with some preparation and strategic planning, you can unlock numerous tax benefits to ease your financial burden and support your family’s future. Before filing, it’s essential to understand the various tax credits, deductions and benefits available to families.
The Dependent Tax Credit can offer significant relief if you have children under the age of 13 or if your spouse cannot care for themself. This year, credits are allowed for up to $3,000 in qualifying expenses. For employees who are offered a dependent care assistance program, you may exclude up to $5,000 for single and married filing jointly filers ($2,500 for married filing separately) this year. These amounts will reduce the expenses available to apply to the Dependent Care Credit. However, the reimbursement through the employer program is typically more substantial than the savings from the credit, as Social Security and income taxes do not apply to the employer program.
Education-related credits, such as the American Opportunity and Lifetime Learning Credits, are available for older dependents. The American Opportunity Credit is for students in their first four years of higher education. It covers educational expenses, including tuition, fees and course materials required for enrollment. One of the key features of this credit is that it can provide up to $2,500 per eligible student per year. It works by receiving a 100% credit on the first $2,000 spent on qualified expenses and a 25% credit on the next $2,000. Up to 40% of this credit (as much as $1,000) is refundable. Meaning that even if there is no tax liability, the family may still receive a refund for a portion of the credit. It’s important to note that the American Opportunity Credit is available only for students pursuing a degree or other recognized education credential and who are enrolled at least half-time. Income limits also apply (starting at $160,000 married filing jointly), so higher-income families may see a phase-out of the available credit.
In contrast, the Lifetime Learning Credit is designed to be more flexible. It is available for all years of post-secondary education. It can be used for undergraduate, graduate and even professional courses—especially those that help you acquire or improve job skills. Rather than being limited to the first four years of college, the Lifetime Learning Credit can be claimed in any year you incur qualified education expenses. The credit is calculated as 20% of the first $10,000 spent on eligible expenses, which means the maximum credit you can claim in a year is $2,000 per tax return. Unlike the American Opportunity Credit, the Lifetime Learning Credit is nonrefundable, so it can only reduce the amount of tax owed and won’t result in a refund if the credit exceeds the tax liability. As with the American Opportunity Credit, income limits (starting at $160,000 married filing jointly) may reduce or eliminate the ability to claim the Lifetime Learning Credit.
A family can’t claim both credits for the same student in the same tax year. Choosing which credit to claim or determining eligibility for one or both depends on the family’s specific circumstances, including the student’s enrollment status, the amount spent on qualified expenses, and income level.
Students who receive scholarships may typically exclude the cost of tuition, books and supplies from income as qualified expenses. However, the IRS treats the portion of scholarships for room and board, travel, and optional equipment as taxable income. A critical factor in determining taxability is whether the scholarship is awarded based on merit or comes with a work requirement.
Scholarships or fellowships that require a student to perform certain services, such as teaching, research, or other duties, as a condition for receiving the award are often treated as compensation. Even if the payment is labeled as a “scholarship” or “grant,” if the student must work in exchange for the funds, the IRS usually considers that money taxable income rather than a tax-free scholarship. Families with a student receiving a scholarship should keep detailed records, as the institution that grants the scholarship is not required to withhold any taxes from the proceeds that may result in taxable income to the child.
Special “kiddie tax” rules apply to dependent children with unearned income. These rules are meant to discourage property transfer to dependents at lower income rates. When applicable, any unearned income exceeding $2,600 (2024) is taxed at the parent’s marginal tax rate. That income may also be subject to the 3.8% net investment income tax when applicable to the parent. Families who include their dependent children’s investment income on their return may be able to deduct more investment interest expense if they choose to itemize their deductions instead of taking the standard deduction. Evaluating the net effect on the parent’s tax return is essential.
A consultation with your financial advisor and tax professional early in the year can provide valuable insights and help you navigate the nuances of your specific situation, ensuring that you take advantage of any available deductions or credits. Every family’s situation is unique, so take the time to plan and consult with experts to ensure a successful tax season.
IMPORTANT DISCLOSURES: The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards is not engaged in rendering legal, accounting or tax preparation services. Specific questions on taxes or legal matters as they relate to your individual situation should be directed to your tax or legal professional.