Recently-released IRS Publication 4694highlights various tax breaks that may be available to an individual who is raising a grandchild. This is becoming more common place and the law is tricky when trying to determine the correct treatment and provide the most benefit to the taxpayers. Here is brief overview of some of the key items to look at when making your determination. As usual, your individual circumstance will determine the correct and best treatment.
Head of household filing status
An individual who is considered unmarried and has a qualifying child may be eligible to use head of household as his or her filing status. It generally is more favorable than the single filing status. There are many complicated rules surrounding this status, so additional care needs to be taken to review how these provisions apply to your specific situation.
Exemption for the child
A grandparent who has a child living with him or him may be able to claim the child as a dependent and, if so, qualify for other tax breaks, as noted below.
Earned income credit
A grandparent who is working and has a qualifying child living with him or her may be able to take the EIC, even if the grandparent is 65 years of age or older. This could generate a refund even if the grandparent owes little or no tax.
Child tax credit
A grandparent who is raising a grandchild may be able to take the Child Tax Credit (CTC) and, under specific circumstances, the additional child tax credit. The latter may provide a refund even if no federal income taxes are owed.
For 2010, individuals may claim a maximum $1,000 CTC for each qualifying child the taxpayer can claim as a dependent. The child must be under 17 and a U.S. citizen or resident alien. Income limits apply to determine if you are eligible for this credit.
Credit for child and dependent care expenses
This credit may be available if a grandparent pays someone to care for a qualifying individual, i.e., a dependent under age 13, or his or her spouse or a dependent who is physically or mentally not able to care for himself or herself, while the grandparent works or looks for work.
Qualified education expense
There are several tax breaks that may be available to a grandparent who pays his or her grandchild’s education costs. These include:
… Education credits. An individual taxpayer may claim an income tax credit for the Hope scholarship tax credit (renamed the American opportunity tax credit (AOTC) for 2010) and the Lifetime Learning credit for higher education expenses at accredited post-secondary educational institutions paid for themselves, their spouses, and their dependents. The AOTC is available in 2010 for qualified expenses of the first four years of undergraduate education; the Lifetime Learning credit is available for qualified expenses of any post-high school education at “eligible educational institutions.” Both credits can’t be claimed in the same tax year for expenses of any one student, and it phases out for higher-income taxpayers. For tax years beginning in 2010, individuals may elect a personal, partially refundable tax credit equal to 100% of up to $2,000 of qualified higher-education tuition and related expenses plus 25% of the next $2,000 of expenses paid for education furnished to an eligible student in an academic period. Taxpayers may elect a Lifetime Learning credit equal to 20% of up to $10,000 of qualified tuition and related expenses paid during the tax year. The maximum credit is $2,000. Unlike the AOTC/Hope credit, which is available for the qualifying expenses of each qualifying student, the Lifetime Learning credit is available only per taxpayer.
… Coverdell Education Savings Accounts (CESAs). Taxpayers can contribute up to $2,000 per year to CESAs in 2010, formerly called education IRAs, for beneficiaries under age 18 (and, in 2010, special needs beneficiaries of any age). The account is exempt from income tax, and distributions of earnings from CESAs are tax-free if used for qualified education expenses.
… Qualified Tuition Programs (QTPs) —529 Plans. A person can make nondeductible cash contributions to a QTP/529 plan on behalf of a designated beneficiary. The earnings on the contributions build up tax-free, and distributions from a QTP are excludable to the extent used to pay for qualified higher education expenses. State credits or dedcutions may also apply depending on the specific 529 and state law.
… Higher Education Exclusion for Savings Bond Income. Qualified U.S. savings bond income is excluded if redemption proceeds don’t exceed qualified higher education expenses. The exclusion phases out at higher levels of modified adjusted gross income. Qualified higher education expenses are tuition and fees required for the enrollment or attendance of taxpayer, taxpayer’s spouse or any dependent for whom taxpayer is allowed a dependency exemption, at an eligible educational institution, e.g., most colleges, junior colleges, nursing schools and vocational schools.
… Deduction for Interest on Qualified Education Loans. Qualifying individuals may claim an above-the-line deduction for up to $2,500 of interest paid on a qualified higher education loan, i.e., any debt incurred by the taxpayer solely to pay qualified higher education expenses that are: (1) incurred on behalf of the taxpayer, the taxpayer’s spouse, or any dependent of the taxpayer as of the time the debt was incurred; (2) paid or incurred within a reasonable period of time before or after the debt is incurred; and (3) attributable to education furnished during a period when the recipient was an eligible student (as defined for the AOTC/Hope credit purposes, i.e., at least a half-time student).
Medical and dental expenses
An individual who itemizes can deduct the amount by which certain unreimbursed medical and dental expenses paid during the year for himself or herself, his or her spouse, and his or her dependents exceed 7.5% of his adjusted gross income.