College students combine many sources of funds to pay for their education, including personal savings, family savings, income from jobs, scholarships, and/or student loans. As the percentage of funds from the student’s sources increases, parents risk losing the student as a dependent on their tax return. Not only do the parents lose the exemption deduction, but they also lose available higher education tax benefits (the Hope scholarship, American opportunity, and lifetime learning credits, and the tuition deduction). The combined effects can be significant in dollar terms. In addition to these tax issues, there are other material financial issues at stake with the loss of dependent status.
Taxpayers and tax professionals need to carefully evaluate the impact that the sources of college funding can have on the net tax and financial position of the family unit. Blindly assuming that a student qualifies as a dependent on the parents’ tax return can result in noncompliance with the tax law and can have other financial implications (for example, for benefits provided by the parents’ employer and federal student aid calculations). With some advance preparation, tax professionals can plan for the dependency exemption issue and maximize the family’s net tax savings.
Escalating College Costs
College costs continue to increase at a rate greater than inflation. The average annual cost of college for 2007–2008, including undergraduate tuition, room, and board, was $13,424 for a four-year public university and $30,393 at a private institution. 1 Many parents begin saving early for their child’s education. The introduction of qualified tuition plans (QTP) under Sec. 529 in 1996 provided a tax-effective vehicle for college education savings. As of December 2008, nearly $105 billion in assets was invested in more than 11 million QTP accounts. 2 Many of the student beneficiaries of these plans are now entering college, and the tax implications of plan distributions should be considered before making withdrawals from the accounts.
Given current economic conditions, students are borrowing more money for higher education than ever before. The average student loan debt for those graduating during the 2003–2004 academic year was $12,750 for public institutions and $16,950 for private institutions. 3 More recent data issued by the Project on Student Debt indicates that the average debt level for graduating seniors has increased to $19,200 and $22,125 for those graduating from public and private universities, respectively. The percentage of students with student loans rose to 66.4% in 2004. 4 Both student loans and QTPs have a direct impact on the support test for a qualifying child.
What Are the Requirements to Remain a Dependent?
A dependent is defined under Sec. 152(a) as either a qualifying child or a qualifying relative. To be a qualifying child under Sec. 152(c), a student must meet four tests:
- Relationship: The child must be the taxpayer’s child or stepchild (whether by blood or adoption), foster child, sibling or stepsibling, or a descendant of any of them.
- Age: The child must be under age 19 or a full-time student under age 24 at the end of the year. To be considered a full-time student, the child must be enrolled for the number of hours or courses the school considers to be full time and must be a student for at least five months during the year.
- Residency: The child must live with the taxpayer for more than one-half of the year. The child is considered to live with the taxpayer while he or she is temporarily away from home due to education, illness, business, vacation, or military service.
- Support: The student cannot have provided more than one-half of his or her own support.
If a student meets these four tests, the parents may claim the exemption if the student also meets the general dependency tests under Sec. 152(b). The general tests include:
- Marital status: If married, the student did not file a joint tax return for the year, unless the return is filed only to claim a tax refund and no tax liability would exist for either spouse.
- Citizen or resident: The student must be either a U.S. citizen, resident, or national or a resident of Canada or Mexico.
The support test for a qualifying child is the main focus of the remainder of this article. We assume that if the support test is met, the child meets the remaining requirements to be a dependent of the taxpayer.
Amount of Support Provided by the Student
To determine whether the student provided more than one-half of his or her support, the amount provided by the student must be compared with the total amount of support the student received from all sources. The amount provided by the student may come from the student’s own income or student funds. Only the amounts actually spent are considered support provided by the student.
The IRS provides a worksheet to help taxpayers evaluate the support test. 5 The first section of the worksheet calculates the amount of support provided by the student, the second section totals household expenses, and the third section determines the student’s total support expenses. As with any attempt to simplify a complicated calculation, the form does not take into account some of the nuances of the calculation. For example, the household expense section is not designed to accommodate a college student living at home for a portion of the year and living either on or near campus for a portion of the year.
The support test depends on two factors: the source of funds and total expenses. Regs. Sec. 1.152-1(a)(2) provides that support includes food, shelter, clothing, medical and dental care, education, and other similar items. Generally, the actual cost incurred is included in the support total, except for lodging and capital expenditures, which are valued at fair market value (FMV).
Over the years, the courts have ruled on specific items that do and do not count in determining total support expenses. Typical expenses for a college student might include tuition and fees, lodging and meals, transportation, clothing, and personal expenses. Health insurance premiums plus out-of-pocket medical and dental expenses would also be included in total support. However, the amount paid by the insurance provider would not be included. 6
Whether the cost of operating an automobile is a support item depends on whether its use benefits the individual. 7 In many cases a car is purchased and registered in the parents’ names and the parents allow the student to use the car full time. Because the parents own the car and did not give it to their child, the cost of the car is not included in the child’s total support. However, the parents’ costs for operating the car are included in the parent’s portion of the child’s support. The car must be registered in the child’s name for the purchase price of the vehicle to be included in total support. The second issue regarding autos is when the student purchases a vehicle. Rev. Rul. 77-282 provides that in the year the child purchases a vehicle, the vehicle’s FMV is included in total support and is considered support provided by the child. 8
The FMV of lodging is its fair rental value. No additional amount can be taken into account for real estate taxes, repairs, and utilities if they are reflected in fair rental value. 9 The amount of lodging and other household expenses attributed to the support of an individual living in a household equals the proportion of fair rental value and expenses reflecting the individual’s per capita proportionate share. This proportionality rule applies to lodging, utilities, and food. The proportionality rule should be altered if some members of the household are present for significantly greater periods than others. 10 For instance, blindly allocating summer months to the parents’ portion of the support calculation may not hold if the child has a summer internship in another city or attends summer classes.
Example 1: Child S attends a qualifying educational institution during the traditional academic school year, September–April. S lives with his parents during the summer months, May–August. Support attributable to S during the summer months would include any specific expenses incurred plus his per capita share for four months’ lodging, utilities, and food. Assume that the fair rental value of the parents’ home is $30,000 annually (excluding utilities). Annual utilities and food expenditures are $3,600 and $12,000, respectively. Therefore, the parental contribution to S’s support for the summer months for lodging, utilities, and food is $2,500 ($30,000 × .25 × 4⁄12), $300 ($3,600 × .25 × 4⁄12), and $1,000 ($12,000 × .25 × 4⁄12), respectively, totaling $3,800.
Certain expenses are not included in total support. Income taxes and Social Security and Medicare taxes paid from the individual’s own income are excluded from total support under Rev. Rul. 58-67. 11 Sec. 152(f)(5) excludes from total support scholarships received by the student. For example, assume that the parents contribute $5,000 to S’s support, S receives a $7,000 scholarship, and S contributes $2,000 to his support. By excluding the scholarship from total support, S provides less than one-half of his own support ($2,000 ÷ $7,000 = 29%) and remains a dependent of the parents. Without this provision, S would have provided more than one-half of his own support ($9,000 ÷ $14,000 = 64%).
Source of Funds
Students use many funding sources to pay for their education and living expenses while in college. These include parents’ savings, personal savings, income from part-time jobs, student loans, gifts from family members, scholarships, and funds from tax-advantaged savings vehicles. The source of funds will determine whether the expenses are considered support provided by the student or the parents.
Funds provided from parents’ savings are considered support provided by the parents, and funds withdrawn from the student’s personal savings are considered support provided by the student. Accounts set up under the Uniform Gift to Minors Act (UGMA) become the property of the student at the time the account is set up, and the custodian has the legal fiduciary responsibility to handle the money for the benefit of the minor. When the student reaches age 18 or 21, depending on the state, the student takes control of the account. Since the account is the student’s property, any funds used from the account are considered support provided by the student.
Many students work at least part-time while in college. To the extent the student uses current income to pay for expenses, those funds are counted as support provided by the student. Under Regs. Sec. 1.152-1(a)(2)(ii), “in computing the amount which is contributed for the support of an individual, there must be included any amount which is contributed by such individual for his own support, including income which is ordinarily excludable from gross income.” Therefore, gifts made to the student are included in total support if they are used for his or her support.
During difficult economic times, more students turn to student loans to help finance their education. The federal student loan borrowing limits for most undergraduate students are currently $5,500 for the first year of study, $6,500 for the second year of study, and $7,500 for the remaining years. 12 Private student loans may also be used to fill in the gap between the cost of education and the funds available through federal aid programs and the student’s family. When the student obtains a loan that he or she is obligated to repay, those amounts are considered support provided by the student. 13 The designation of those funds as student provided may give the parents difficulty with the support test. If parents borrow money that they are obligated to repay, the funds are considered provided by the parents.
Example 2: S attends college full-time. He works a part-time job throughout the year, using $2,500 of those earnings to pay for required equipment and school supplies. His grandparents give him $1,000 as a birthday gift, $500 of which he uses to purchase textbooks. S withdraws $1,500 from a UGMA account, set up by his parents on his tenth birthday, to help pay tuition. He also receives federal student loans in the amount of $4,500 (his debt), which he applies toward tuition, room, and board. S’s parents use the proceeds of a $5,000 personal loan to make direct payments to the institution for tuition, room, and board. They also give S $1,000 for clothing, gasoline, prescribed medications, and other personal expenses. Parental support for the summer months in which S lives with his parents (lodging, utilities, and food) is $3,800. The parents may claim S as a dependent because he provides only 48%, less than one-half, of his support. (See Exhibit 1.)
Example 3: Assume the same facts as in Example 2, except that instead of the parents taking out a personal loan for $5,000, S borrows the additional $5,000 through private student loans. S’s total contribution increases to $14,000, and the parents’ contribution decreases to $4,800. S now provides more than one-half of his own support ($14,000 ÷ $18,800 = 74%), so he no longer qualifies as a dependent of his parents.
Examples 2 and 3 demonstrate how slight alterations in funding sources can determine which taxpayer may claim the dependency exemption. The tax benefits of the parents claiming the student as a dependent usually warrant planning the source of funds in an effort to preserve the dependency exemption and educational credits; however, this may not always be the case. A high-income family should analyze who claims the dependency exemption in terms of potential phaseouts, tax credits, alternative minimum tax, and nontax implications. In other words, something as simple as which taxpayer claims the exemption deduction (parent or child) can have numerous tax consequences.
Sec. 529 Plan Distributions
An increasing number of students are now using funds from Sec. 529 plans (also known as qualified tuition programs, or QTPs) to help pay for their education. In general, any distribution is includible in the gross income of the distributee (student) in the manner provided in Sec. 72. 14 However, to the extent the distributions are used for qualified education expenses, they are excludible from gross income. 15 If the distribution exceeds qualified education expenses, a portion is taxed to the distributee and will usually be subject to a 10% penalty tax.
Under Sec. 529(e)(3), qualified education expenses include the amounts paid for tuition, fees, books, supplies, and equipment required for enrollment, plus the cost of room and board. For 2009 and 2010, qualified higher education expenses also include the purchase of any computer technology or equipment or internet access and related services. Under Sec. 529(e)(3)(B)(ii), room and board is limited to the greater of:
- The allowance for room and board determined by the institution that was included in the cost of attendance for federal financial aid purposes; or
- The actual amount charged by the institution if the student is living in housing owned by the institution.
Any taxable QTP withdrawals are included in the distributee’s taxable income (the proposed regulations refer to qualified state tuition plans, or QSTPs). Under Prop. Regs. Sec. 1.529-1(c), “distributee” is defined as “the designated beneficiary or the account owner who receives or is treated as receiving a distribution from a QSTP.” Under the proposed regulation,
if a QSTP makes a distribution directly to an eligible educational institution to pay tuition and fees for a designated beneficiary or a QSTP makes a distribution in the form of a check payable to both a designated beneficiary and an eligible educational institution, the distribution shall be treated as having been made in full to the designated beneficiary.
Therefore, if the funds are distributed to the student, the student is taxed on the earnings amount associated with any excess distributions. The question that still remains unclear is who is considered to have contributed the funds toward the student’s support—the student or the account owner (who often is a parent).
In an attempt at simplification, the Working Families Tax Relief Act of 2004 (WFTRA) 16 established a uniform definition of “qualifying child” for the purposes of five commonly used provisions, including the dependency exemption. Prior to the amendments under WFTRA, the support test to qualify as a dependent required that the taxpayer (parent) provide more than one-half of the dependent’s support. Under WFTRA, the support requirement provides that a child is not considered a qualifying child if the child provides over one-half of his or her own support. 17 Although the IRS has not updated the regulations under Sec. 152 since the passage of WFTRA, presumably the regulations and case law interpreting support would still apply.
Under Regs. Sec. 1.152-1(a)(2)(ii), any amount contributed by an individual for his or her support is considered, including income that is ordinarily excludable from gross income. Since the student is taxed on the distributions from the QTP or the distributions are excluded from the student’s gross income, the regulation supports the position that the QTP funds (total distributions from the Sec. 529 plan) are contributed by the student for his or her support.
The other line of reasoning is that the account owner retains control over the funds, including the withdrawal of the assets from the QTP. According to Prop. Regs. Sec. 1.529-1(c):
Account owner means the person who, under the terms of the QSTP or any contract setting forth the terms under which contributions may be made to an account for the benefit of a designated beneficiary, is entitled to select or change the designated beneficiary of an account, to designate any person other than the designated beneficiary to whom funds may be paid from the account, or to receive distributions from the account if no such other person is designated.
Typically a parent or grandparent is the account owner, but anyone can set up a QTP for either a related or an unrelated individual. The argument could be made that because the account owner controls whether a distribution is made and the amount of the distribution, and can even withdraw funds for himself or herself, the distribution from a QTP should be considered provided by the account owner for purposes of the support test. However, the estate and gift tax treatment of QTPs discussed below supports the position that the student should be treated as the person providing the support.
This possible treatment of QTP funds is similar to the incidents of ownership analysis for the estate tax treatment of life insurance. Under Sec. 2042, life insurance proceeds are included in the decedent’s estate if at the time of death he or she possessed any incidents of ownership. Regs. Sec. 20.2042-1(c)(2) provides that “incidents of ownership” refers to the right of the insured or his or her estate to the economic benefits of the policy. It includes the power to change beneficiaries, to pledge the policy as security for a loan, or to surrender or cancel the policy. Any one of those “string” powers results in the decedent’s being treated as owning the policy, resulting in the inclusion of the life insurance in the estate. In the case of a QTP, the account owner has the power to change beneficiaries and to cancel the plan by withdrawing the assets on his or her own behalf, thus strongly indicating direct and unrestrictive ownership.
From a gift and estate perspective, Sec. 529(c)(2) provides that contributions to QTPs are treated as completed gifts of a present interest to the plan beneficiary when the money is contributed to the plan, making the contribution eligible for the annual gift tax exclusion. By treating the contribution as a completed gift, generally no amount of the QTP is included in the gross estate of the account owner. 18 However, if the donor elects to treat the contributions to a QTP as made over a five-year period and dies within that five-year period, the portion of the contribution allocated to the period after death is included in the donor’s estate. 19
The gift and estate tax treatment of QTPs was one of the changes made under the Taxpayer Relief Act of 1997. 20 Prior to these changes, contributions to a QTP were treated as incomplete gifts, and the gift tax consequences were determined at the time a distribution was made from the account. 21 In addition, the value of a QTP attributable to the contributions made by the individual was included in the contributor’s estate if the contributor died before such amounts were distributed. 22 The Joint Committee on Taxation’s explanation for all the 1997 QTP changes was to “allow greater flexibility in the use of such programs.” 23 The changes in the gift and estate tax consequences of QTP contributions made the plans more attractive as college savings vehicles. On the other hand, completed gift treatment at the time of contribution weakens the argument that the funds belong to the account owner for purposes of the support test, even though the owner still has unrestricted control over the funds in the QTP.
The estate and gift tax treatment of a change in beneficiaries follows the completed gift treatment of the contribution, providing additional support for the position that QTP distributions will be treated as funds provided by the student. Prop. Regs. Sec. 1.529-5(b)(3) states that
a transfer which occurs by reason of a change in the designated beneficiary, or a rollover of credits or account balances from the account of one beneficiary to the account of another beneficiary, will be treated as a taxable gift by the old beneficiary to the new beneficiary if the new beneficiary is assigned to a lower generation than the old beneficiary.
Treating the “old beneficiary” as the transferor for gift tax purposes supports treating the student as the provider of the QTP funds for purposes of the support test.
The dichotomy between transfer tax
treatment and account ownership raises
concern over the potential for dubious
tax avoidance schemes. For instance, a
taxpayer could set up multiple QTPs,
each with unique beneficiaries, utilize
five-year annual exclusion, and later change all the account beneficiaries to one individual. 24 The advance notice of proposed rulemaking for the proposed regulations under Sec. 529 (advance notice) indicates that the forthcoming rules will deal with this potential abuse. 25 The IRS has not yet addressed the treatment of QTP distributions for support purposes in any publication or release, and it does not do so in the advance notice. 26 To date there are no court cases involving education account distributions and the support issue. Whether the withdrawals from a QTP are sourced to the parent or the student will in many cases determine whether the student meets the definition of a qualifying child.
Example 4: Several years ago A and B opened a QTP with a $20,000 contribution, designating their daughter D as the beneficiary. During the current year, the parents direct the payment of an $8,000 tuition bill from the QTP directly to the qualified educational institution that D attends. They contribute another $5,000 to D’s support from their personal savings account. D contributes $2,000 to her own support from her savings. Assume that the $8,000 tuition payment is considered support provided by D. Under these circumstances, D provides more than one-half of her own support ($10,000 ÷ $15,000, or 67%), thereby disqualifying her as a dependent of her parents. Conversely, assume that the QTP distribution is attributable to the parents. In this case, D would have contributed 13% toward her support ($2,000 ÷ $15,000), compared with the parents’ 87% ($13,000 ÷ $15,000), qualifying her as the parents’ dependent.
As in the previous examples, Example 4 demonstrates the importance of planning for the timing and amounts of QTP distributions. Given the large dollar amounts currently invested in Sec. 529 plans, Treasury or Congress need to clarify the treatment of the distributions from these plans as they affect the dependent support test. With individual Sec. 529 plan maximums now exceeding $200,000 (and over $300,000 in many states), 27 QTP balances may be large enough to cover all the qualified educational expenses at even the priciest private institutions. The sourcing of distributions from these plans to either the account owner or the beneficiary will determine whether the student qualifies as a dependent on the parents’ tax return.
Coverdell Education Savings Account Distributions
Some students have funds available from Coverdell education savings accounts. Similar to QTPs, contributions to these accounts are not tax deductible, and the accounts grow tax free until distributed. In general, any distribution is includible in the gross income of the distributee (student) in the manner provided in Sec. 72. 28 However, to the extent the student uses the distributions for qualified education expenses, the distributions are excludible from gross income. 29 If the distribution exceeds qualified education expenses, a portion is taxed to the beneficiary and will usually be subject to a 10% penalty tax. For gift tax purposes, a contribution to a Coverdell account is treated as a completed gift to the beneficiary when the funds are contributed to the account. 30 The balance in the account is not included in the estate of the donor or responsible person.31
Technically, the Coverdell account is a custodial account, which means that the beneficiary becomes the legal account owner when the student reaches the age of 18 or 21, depending on the state. Prior to the student’s reaching majority, a “responsible person” (usually a parent) oversees the account. The responsible person decides when funds will be distributed and if and when funds will be rolled over to a family member’s account. The responsible person is not allowed to withdraw the funds for himself or herself.
The IRS pre-approved account agreement allows the donor to make two choices when setting up the account. 32 The first choice involves what happens when the beneficiary reaches the age of majority. The donor has the option of allowing the responsible person to continue to control the account after the beneficiary reaches legal age; otherwise control of the account will pass to the beneficiary at that point. The second choice involves whether the responsible person has the authority to change the designated beneficiary.
The Code generally treats the Coverdell account like a Sec. 529 plan from an income tax and gift and estate tax perspective, supporting the position that the student contributes the funds for his or her support. The fact that the Coverdell account is technically a custodial account further supports this position.
The distinctions between a QTP and a Coverdell account weaken the position that the funds are provided by the account owner. When setting up a Coverdell account, the account owner must designate a responsible person to oversee the account, usually a parent. The responsible person may or may not remain in control of the account after the beneficiary reaches the age of majority and may or may not have the right to change the beneficiary.
If the student becomes the
responsible person when he or she
reaches majority, the argument that the
funds are provided by the account owner
becomes much more difficult because the
account owner has no control over the
distribution of the funds or the
beneficiary. If both the account owner
and the responsible person are a parent,
the argument that the funds are provided
by the parent is similar to the argument
for the QTP. However, the Coverdell
account owner does not have the option
of reclaiming the funds for himself or
herself as the QTP owner does. Under
Sec. 530(b)(1)(E), any amount remaining
in a Coverdell
account is treated as distributed to the beneficiary 30 days after the beneficiary reaches age 30 and is included in the beneficiary’s gross income. Sec. 530(d)(5) gives the beneficiary the option of contributing, within 60 days of receipt, the remaining balance to another Coverdell account for the benefit of a family member as long as the new beneficiary has not attained age 30. The otherwise taxable distribution would then be excluded from gross income.
As with the QTP distributions, whether the withdrawals from a Coverdell account are sourced to the parent or the student will in many cases determine whether the student meets the definition of qualifying child. Again, Treasury guidance on the sourcing of these funds is lacking.
Impact of Dependent Designation
Whether or not a college student qualifies as a dependent affects both the parents’ and student’s tax returns. If the student qualifies as a dependent of the parents, the parents are allowed the following benefits, subject to varying phaseouts and limitations:
- Exemption deduction;
- Hope scholarship, American opportunity, or lifetime learning credit; and
- Tuition and fees deduction.
If the student provides more than one-half of his or her support, the student qualifies for the above benefits on his or her tax return.
For 2010, the dependency exemption amount is $3,650. 33 For 2009 and prior years, the dependency exemption was phased out for higher-income taxpayers. 34 If the student can be claimed as a dependent (even if the taxpayer does not claim the dependency deduction), the student cannot take the exemption on his or her tax return. Another consideration for those taxpayers subject to alternative minimum tax (AMT) is that the dependency exemption is disallowed for AMT purposes.
The maximum Hope scholarship credit (renamed the American opportunity credit for 2009 and 2010) is $2,500, while the maximum lifetime learning credit is $2,000. Both credits phase out based on modified adjusted gross income (MAGI). The phaseout for 2010 is between $80,000 and $90,000 of MAGI ($160,000 and $180,000 for joint returns).
No double benefits are allowed for the same qualified education expenses. 37 The qualified education expenses are either considered tax-free distributions from the Coverdell or QTP account, used for claiming the tuition and fees deduction, or used for calculating the education credits. The same expenses cannot be used for more than one benefit.
Most traditional students will meet the definition of qualifying child for the year they enter college because they were living at home for eight months while completing high school. Due to the potentially higher level of parental support during the last year of high school, parents may be able to take a larger distribution from a QTP without being concerned about losing the student as a dependent in the first year he or she enters college. Disregarding the dependency support test issue, parents are often inclined to defer distributions to later years to maximize the tax-favored status on earnings.
The preamble to the Sec. 529 proposed regulations indicates that
the IRS and the Treasury Department propose to adopt a rule that, in order for earnings to be excluded from income, any distribution from a Sec. 529 account during a calendar year must be used to pay QHEEs (Qualified Higher Education Expenses) during the same calendar year or by March 31 of the following year. 38
Careful calculation of parental support may allow a larger distribution from the QTP during the student’s first semester without jeopardizing the dependent exemption for the parents.
Example 5: D, who is supported by her parents, starts college in September 2010 after graduating from high school in June (see Exhibit 2). D contributes $1,000 of her summer employment earnings toward spending money during the fall semester. She attends an in-state institution, so her tuition is $3,600 per semester and her room and board is $3,800 per semester. D can provide up to an additional $11,000 of support without losing her dependent classification on the parents’ return ($12,000 parent support – $1,000 spending money). If she receives $11,000 from her QTP, $7,400 would cover the fall qualified expenses and the remaining $3,600 would cover spring qualified expenses.
QTP and Coverdell distributions can be timed for maximum family tax savings. Taxpayers and tax professionals need to carefully evaluate the impact of the dependency exemption on the net tax position of the family unit. In many instances, high-income taxpayers may not be realizing any tax benefit from the dependency exemption due to the phaseouts of the exemption and tax credits. When the parents are subject to AMT, they lose the benefit of the dependency exemption. Appropriate planning can improve the family’s overall tax position and avoid “wasting” the dependency exemption.
Parents and tax professionals can no longer assume that a college student will remain a dependent of the parent until he or she graduates. With the variety of funding sources students use to pay for the ever-increasing cost of higher education, many are likely to provide over one-half of their support at some point during their college years. Student-provided funds include student loans when the student will be repaying the loan, income from part-time jobs, and student savings. Distributions from Sec. 529 plans and Coverdell education accounts also need to be considered as possible student-provided support contributions. Given the large dollar amounts currently invested in these plans, Treasury or Congress need to clarify the treatment of distributions as they affect the dependent support test. The implications of a student no longer qualifying as a dependent extend beyond the parents’ and student’s tax returns to include benefits provided through the parents’ employer and federal student aid calculations. As is often the case, taxpayers and tax professionals are advised to approach the dependency issue with prudent planning.
1 Snyder, Mini-Digest of Education Statistics, 2008. NCES2009-021 (National Center for Education Statistics, Institute of Education Sciences 2009).
2 College Savings Plans Network, 529 Plan Data, “Program Statistics, December 31, 2008.”
3 Id. at 1.
5 Publication 17, Your Federal Income Tax (2009), Worksheet 3-1, Worksheet for Determining Support.
6 See McGuire, 77 T.C. 765 (1981).
7 Rev. Rul. 77-282, 1977-2 C.B. 52.
9 Abbott, 13 T.C.M. (CCH) 113 (1954).
10 Moore, 13 T.C.M. (CCH) 65 (1954).
11 Rev. Rul. 58-67, 1958-1 C.B. 62.
13 McCauley, 56 T.C. 48 (1971).
14 Sec. 529(c)(3).
15 Sec. 529(c)(3)(B).
16 Working Families Tax Relief Act of 2004, P.L. 108-311.
17 Sec. 152(c)(1)(D).
18 Sec. 529(c)(4)(A).
19 Sec. 529(c)(2)(B).
20 Taxpayer Relief Act of 1997, P.L. 105-34, §211.
21 Former Sec. 529(c)(2).
22 Former Sec. 529(c)(4).
23 Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997 (JCS-23-97) (December 17, 1997), 27.
24 Gerzog, “College Saving Plans: Not Just for Education,” 122 Tax Notes 1267 (March 9, 2009).
28 Sec. 530(d)(1).
29 Sec. 530(d)(2)(A).
30 Sec. 530(d)(3).
32 Form 5305-EA, Coverdell Education Savings Custodial Account.
33 Rev. Proc. 2009-50, 2009-45 I.R.B. 617.
34 For 2009, the $3,650 exemption amount began to phase out at adjusted gross income of $250,200 and reached the maximum phaseout after $372,700 for a joint return, $208,500–$331,000 for head of household, and $166,800–$289,300 for single individuals. Rev. Proc. 2008-66, 2008-45 I.R.B. 1107.
35 Sec. 222.
36 The tuition and fees deduction expired for tax years beginning after December 31, 2009. As of this writing, four bills were pending before Congress that would extend Sec. 222 for 2010 or make it permanent.
37 For detailed information regarding the education benefits, see Zook and Zook, “Tax Benefits for Education,” 41 The Tax Adviser 464 (July 2010), and IRS Publication 970, Tax Benefits for Education (2009).
Nancy Nichols is the Journal of Accounting Education Research Professor, Susan Ferguson is an instructor of accounting, and William VanDenburgh is the Robinson, Farmer, Cox Faculty Fellow Assistant Professor of Accounting at James Madison University in Harrisonburg, VA. For more information about this article, contact Prof. Nichols at email@example.com.