In the midst of tax season, I can’t help but notice that some deductions, exemptions, and credits are more common than others. Some are so common, in fact, that taxpayers expect to get them no matter what.
But like everything else to do with the tax code, it’s not that simple. Requirements must be met to get even the most common of these tax-saving devices.
Here is a list describing some common tax scenarios and the requirements for each, in plain English.
1. Student Tax Credits
Most of the time, if you’re a college student, you pay nothing in taxes. In fact, even if you pay nothing, you may still even get a refund.
The two pertinent credits for students are the American Opportunity Credit and the Lifetime Learning credit, which both use Form 8863.
- American Opportunity Credit
The American Opportunity Credit is a tax credit for those enrolled in higher education at least half-time. What is considered half-time is defined by your educational institution itself, so you’ll have to check with the school you’re attending.
The American Opportunity Credit maxes out at $2,500, and $1,000 is refundable. So even if you paid no taxes, you might still get a refund using this credit. The American Opportunity Credit is only available for the first four years of post-secondary education. This means basically that the credit only applies to undergrad.
Finally, you have to have qualified education expenses to take this credit, which are reported on Form 1098-T. However, these qualified expenses have to be netted by subtracting the amount of tax-free grants and scholarships.
- Lifetime Learning Credit
This credit picks up where the American Opportunity Credit leaves off, in that, the Lifetime Learning Credit can be used for qualified tuition expenses after the first four years of undergrad, toward graduate school, or for classes that don’t lead to a degree.
Additionally, for the Lifetime Learning Credit, you don’t even have to be enrolled half-time. All it requires is enrollment in at least one course. The maximum credit is $2,000, and none of it is refundable.
It certainly comes in handy, though, to soak up taxes that are owed while you’re a student. So, it’s possibly not quite as generous as the American Opportunity Credit, but don’t look a gift-horse in the mouth.
2. Child Tax Credit
The Child Tax Credit is very appropriately named because it gives a credit up to $1,000 for each qualifying child.
The definition of ‘qualifying child’ is where many get tripped up, thinking that this credit is the same as a dependency exemption. It is not.
- The child cannot be more than 16 years old at any time during the tax year in question. If your child is 17, he or she does not qualify.
- The child must pass the relationship test by being your child, stepchild, foster child, brother, sister, stepbrother, stepsister, or descendant of any of the aforementioned.
- You have to provide more than half the support for the child.
- Your child has to be claimed as a dependent on your tax return, so while it’s possible to claim a dependent that doesn’t meet the Child Tax Credit standards, the opposite is not true.
- The child must be a U.S. Citizen or U.S. resident alien.
- He or she must have lived with you for more than half the year, with temporary absences permitted.
- Child Tax Credit phases out at $55,000 for married filing separately, $75,000 for single and head-of-household filers, and $110,000 for married couples filing jointly.
3. Claiming Dependents
This is probably the least understood tax-saving measure. The rules for who is a dependent vary significantly depending on how the person is classified, and the rules are not intuitive.
So here it goes:
- Qualifying Child
A qualifying child for the purposes of dependency exemptions is very similar to the test for the Child Tax Credit. However, there are two distinct differences.
First, the child must be under 19 at the end of the tax year or under 24, if a full-time student, or any age if totally disabled.
Another significant difference, when it comes to nationality: The child must be a U.S. citizen, national, or permanent resident, but can also be a resident of Canada or Mexico.
- Qualifying Relative
This one is a bit of a catch-all. And, the rules here are even more vague.
A qualifying relative cannot be a qualifying child as relates to you, or anyone else.
Secondly, the person must be related to you in any one of the following ways: child, stepchild, foster child, descendant of the aforementioned, brother, sister, half-brother, half-sister, stepbrother, stepsister, father, mother, grandparent, other direct ancestor, stepfather, stepmother, niece, nephew, half-niece, half-nephew, uncle, aunt, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
It’s worth noting that, if applicable, none of the relationships mentioned end due to divorce, and they don’t have to live with you to qualify. For example, you could claim your son as a dependent, even if he didn’t live with you during the year, assuming the other requirements are met, which I’ll go into now.
To be a qualifying relative, a person also has to have a gross income of less than $3,950, and the taxpayer must provide more than half the support for that person during the year.
Finally, anyone who lives with you for the whole year and meets the gross income and support requirements can be claimed as a qualifying relative, even if not related to you in any way.
The IRS offers middle-class people a big break by allowing for a major deduction against income to fund retirement savings. How much? Assuming you’re not covered under a retirement plan through your employer, you can sock away $5,500 per year, and if you’re over 50 that increases to $6,500.
This is truly amazing for taxpayers because it allows for tax deferral when working, with those taxes being paid when distributions from the IRA kick in, anywhere from 59 ½ to 70 ½ years of age. You’re presumably going to be in a lower tax bracket when you’re older, and if you’re not, this is a good problem to have, so either way you win.
To top it all off, if you’re married and file jointly, most of the time both spouses can deduct up to the maximum contribution, even if one spouse didn’t have any income. For example, if one spouse made $50,000 and the other had no gross income, the couple could deduct $11,000 from their $50,000 gross income, assuming that both spouses were under 50. If both were over 50 in the example, $13,000 can be deducted.
Additionally, your traditional IRA contribution can be made during the first four months of the following tax year. Therefore, you could take your IRA deduction for 2014 now. Just make sure you tell your account manager to note that the IRA deposit was made for 2014 and not 2015.
Finally, you cannot deduct more than you make in a given year. For instance, you can’t deduct the $5,500 if you only made $4,000 gross.
Need help with your tax scenario?
These very common tax-saving mechanisms are widely used, as they should be. The IRS allows them, and they save the taxpayers of this country billions of dollars every year.
But be careful to make certain that the deduction, exemption, and credits here apply to your tax scenario specifically, because if you take a deduction, exemption, or credit that is unmerited, the IRS will most likely reject your return. My suggestion is find a good tax professional to aid in this endeavor.
Dino Tax Co is here for such a purpose, and we’re the beast deal in town. Get in touch with me today – the April deadline is coming up quick.