Once Johnny or Julie is on campus, Uncle Sam offers a couple of education tax credits to help pay the costs. The Hope Scholarship credit can be used for expenses incurred during the first two years of post-secondary education. It can be worth up to $1,650 per student, per year. Graduate and professional-level programs are not eligible. For additional school years, look to the Lifetime Learning credit, which could cut $2,000 off your tax bill. The credit can be used for undergraduate, graduate and professional degree courses for anyone (including yourself if you want to show your kids that the old parental unit can learn a few things, too). Credits usually are more tax beneficial than deductions, but that doesn't mean you should automatically discount the tuition and fees deduction. This tax break lets you subtract up to $4,000 of eligible schooling costs from your income. The deduction's immediate attraction is that it doesn't require you to fill out Schedule A or meet any percentage-of-income minimum. You'll find the deduction right on your 1040 (line 34) or 1040A (line 19). Plus, you can count undergraduate and graduate expenses for your kids even if they aren't full-time students. Shifting rules on income shifting
One former child-related opportunity to lower your tax bill, however, has been dramatically reduced. Previously, many parents shifted some of their higher-taxed investment income to their kids so that the earnings would be taxed at a lower bracket, for example, falling from a possible 35 percent rate to the youngsters' usually 15 percent bracket. That worked well when the law said that earnings of children 14 or older were taxed at the child's rate. In 2006, the age limit was moved up. Now investment income earned by a child up to age 17 falls under the kiddie tax, a provision created in 1986 to keep parents from illegally sheltering income. Under the tougher law, when children 17 or younger have holdings that pay up to $850 in investment income, that amount is tax-free and the next $850 is taxed at the child's rate. Any earnings above that are subject to the kiddie tax, meaning the IRS collects on them at the parent's rate. So your child's earnings are, in essence, added to your taxable income amount. This extra money could push you into a higher tax bracket and could mean the loss (or at least reduced benefit) of some tax deductions and credits that are phased out as income grows. And in 2008, the kiddie tax will apply to the earnings of young investors who are 18, as well as full-time students up to age 23. You can, however, still count on your kids to help lower your tax bill a bit if you own your own business. In this case, by hiring your kids, your company gets a deduction and your child pays income taxes at the youth's lower rate. Just remember, the job and wages must be reasonable. If you pay an excessive salary to your 16-year-old for a job he's not equipped to perform, an IRS examiner is likely to take a closer look. That scrutiny could quickly erase any tax savings you thought you had gained. |