Wednesday, December 5, 2012

Tax benefits of Children Part 2: Exemptions

Another benefit when you have children is the extra tax exemption.

Exemptions are basically deductions based on the size of your household. For each person there is a $3,800 exemption (in 2012). Every exemption can save you $380-$1330 in tax dollars depending on your income and what tax bracket you are in.

As a college student I have heard of parents trying to hang on to that exemption as long as possible, but the reality is if your student child is qualified to file on their own, there are situations when you might want to reconsider. Here is just one scenario:

Scenario: Letting the student child file their own return
(assuming a tax rate of 10%).

If a child is free to file their own taxes, they not only will get their personal exemption  ($380 value), but they will be allowed to take an additional standard deduction ($595 value).

If a parent is in a 35% tax bracket, they are not eligible to take the education credit. (The education credit's income limit for married filing jointly is $180,000).

If the student needs to acquire loans, or at least pay a partial amount for their schooling without scholarship, the value of an education credit could be up to $2,500. (education credits are not discussed in detail here).

Total potential savings = $2,145 = ($380 + 545 + $2500) - ($1330)
Total potential savings = (added value to student) - (parent forgoing the student's personal exemption)

I know not everybody's parents make $180,000+ but the analysis gets more complicated if I hadn't made that assumption.

Everybody's situation is different and each situation should be evaluated independently by your trusted tax adviser.

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