If your kids are making their own dinner reservations for Valentine’s Day, it’s probably time to discuss their financial independence. Once they reach college or turn 19, how you form relationships with your children can have fiscal consequences both good and bad.
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Here’s a quick overview of the pros and cons of letting the young adults in your household stay in the nest or strike out on their own.
The Kids Are All Right
From a tax standpoint, keeping your kids around can help in many ways.
If they are full-time students—meaning they attend school part of five calendar months every year—you can claim them as dependents on your tax return until they turn 24. Having dependents earns you valuable exemptions that lower your taxable income.
That’s not all. You can also write off a number of expenses incurred by or for your children, including medical bills and summer camps.
“There’s quite a few things you can gain by having a dependent [child] on your tax return,’’ says Scott Estill, a tax attorney in Littleton, Colo. ,who previously worked for the IRS.
Paying for college can be a big drag on any family’s finances but there are ways for your kids to offset some of those expenses come tax time.
Education credits allow you to deduct a portion of your kids’ college costs. The American Opportunity Creditprovides a $2,500 tax credit for college tuition and fees per student. The credit has income limits of $90,000 for single filers and $180,000 for joint filers and is available for all four years of a student's undergraduate education.
Alternately, you can deduct up to $4,000 in education expenses per student from your taxable income but these deductions phase out at $80,000 for single and $160,000 for joint filers. You must choose the credit or the deduction—you can’t claim both. (Tax credits are always more valuable than deductions on a dollar-for-dollar basis.)
You’re On Your Own
The IRS makes it easy for grown children to declare their independence. Once an individual turns 19, he is considered an adult by the IRS. If that person earns more than $5,700 a year, he will have to file a tax return and can no longer be considered a dependent on a parent’s return.
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If your kids are young entrepreneurs and earned above $5,700 while younger than 19, they also would have to file a tax return but at the lower child’s income tax rate. But as long as they don’t check any exemptions on their return, you can still claim them as a dependent on your return, explains Estill.
Independence can come in handy when seeking financial aid for college. The expected tuition contribution of a child who has separated from his or her parents is based on his income and assets alone, which unless you’re Miley Cyrus or Justin Bieber will almost certainly be lower than Mom and Dad. A lower expected contribution should lead to more financial aid to cover college costs.
The Department of Education, which administers federal financial aid, knows this and makes it extremely difficult for students to claim their independence. The DOE doesn’t consider a student independent until they turn 24 or they meet one of the following exceptions: they are a graduate student, a military veteran, married, or have their own children.
“If the student is not meeting the statutory definition of independence, they need to get a dependency override [from their college], but this is quite rare,’’ says Mark Kantrowitz, founder of the financial aid websites FinAid.org and Fastweb.com, who puts the success rate at a couple of percent.
Some parents consider cutting off their young adult children as a form of tough love that will instill maturity and responsibility, but if you’re facing a hefty tax bill, you may want to keep them around a little while longer.