Help with tax planning error

[SecondCor521]

Hi all,

I have made a tax planning error that I'd like your help in trying to rectify or minimize.

I have three adult children. For 2020, the older two were not my tax dependents. The youngest was my tax dependent.

In 2020, I withdrew funds from their 529s for various purposes that did not qualify as AQHEE. This resulted in Schedule 1 Line 8 Other Income for each of them. In particular, I withdrew enough to create what I calculate as $1,414 of other income for my youngest (using the formulas from Pub 970 in the QTP chapter).

Because of this other income, they are required to file a federal return based on the criteria in Chart B.

Because they are required to file a federal return, I'll be required to include their income on my Form 8962. Because their total income is close to $12,000 (they had $3,317 in taxable scholarships, $2,848 in taxable Pell Grants, I'm adding in $4,000 for the AOTC, and about $1K at a McDonald's job plus $250 in housesitting income), that's going to decrease the ACA subsidy on my return.

Although they each have individual 529s, I manage them collectively for their collective education expenses and regularly transfer funds back and forth between their accounts as their college plans and costs change.

Is there any proper way you can think of after the fact for me to shift most of that other income from my youngest (who is my tax dependent) to one of my other children?

I thought about re-contributions, but there were no refunds to me for any of my three kids' college expenses within the past sixty days.

I thought about a rollover, but the only distribution within the last sixty days was from my oldest child's account, so I don't think that would help me.

The only idea I've come up so far with is to forgo the AOTC for 2020 for them, which would at least reduce their income by $4,000 and lessen the loss of the ACA subsidy bite by about 1/3. They're a freshman now so I might be able to manage to use it over some subsequent four tax years.

There's really no way I can find to ethically say they're not my dependent in 2020, even though that would get them the EIP1, EIP2, and solve this tax problem. They were a high school student through the spring, lived at home in the summer, and were at college in the fall. They earned a bunch of scholarships, but those don't count for support purposes. And I paid for food, shelter, utilities, etc.

So I think we are stuck, but any other thoughts or options would be most welcome. I haven't plugged the number into my Form 8962 yet, but I think it's about $1800 in ACA subsidy loss.

 

[pb4uski]

You might want to review the reasons why you think you can claim they youngest as a dependent and see if you could reframe in a way that s/he is NOT eligible to be claimed as a dependent.... then Chart A would apply rather than Chart B.

As I read it if they could not be claimed as a dependent on yout tax return then the youngest doesn't have to file a return.

 

[SecondCor521]

Thanks for the reply.

As I read it if they could not be claimed as a dependent on your tax return then the youngest doesn't have to file a return.

Agreed.

You might want to review the reasons why you think you can claim they youngest as a dependent and see if you could reframe in a way that s/he is NOT eligible to be claimed as a dependent.... then Chart A would apply rather than Chart B.

Yeah, I'd love to, but don't think I can. From my OP:

There's really no way I can find to ethically say they're not my dependent in 2020, even though that would get them the EIP1, EIP2, and solve this tax problem. They were a high school student through the spring, lived at home in the summer, and were at college in the fall. They earned a bunch of scholarships, but those don't count for support purposes. And I paid for food, shelter, utilities, etc.

As a follow up, I've been looking at it all morning and have found some things that solve the problem. One was a mistake in the tax preparation program that got fixed today, another was me reporting babysitting income as other income instead of wage or SE income. Those two items fixed my issue, and there are a few other knobs that I realized I can turn as well if necessary.

 

[pb4uski]

Give them a $6k gift then have them turn around and pay you $6k for room and board for the year... then you have not provided more than 1/2 of their support... problem solved!

Somewhat kidding but the point is that there is a lot of wiggle room in the support test.

 

[Philliefan33]

I don’t understand why you are adding the AOC to the dependent income. You can take the AOC as a credit in your return, which in most cases results in the largest benefit for the family. Even if your youngest claims the AOC for themselves, it is a credit not income

 

[SecondCor521]

Yeah, I know.

If it were even close, I'd consider it as an option. I don't know anyone who goes through Pub 501 and does the support test calculations.

The part that I left out - I apparently leave stuff out of my posts here a lot - is that there are numerous other moving parts that are impacted. Notably my filing status would go from HOH to Single, my ACA subsidy would be affected, and I'd lose the $500 other dependent credit. Those things may or may not have been offset by the EIP1 and EIP2, but I decided last fall to make the dependency decision based on the actual facts and circumstances rather than which one would end up with less taxes collectively.

I have made a note to look at the dependency status of my two youngest offspring for 2021. I feel like I have plenty of time to start charging reasonable rent or something where they are legitimately not my dependent.

 

[Philliefan33]

I just thought of something else. If you do a web search for “Bogart tax tools” you will find a page with multiple links to tax-related calculators. The Education Credits calculator takes a little bit of effort to learn, but is very powerful. There is an optimization function that lets you pull a lot of levers to come up with the best way of allocating payments. (Hint: to get the optimizer to work, you have to include a number for living expenses beyond room & board paid to the school)

 

[SecondCor521]

I don’t understand why you are adding the AOC to the dependent income. You can take the AOC as a credit in your return, which in most cases results in the largest benefit for the family. Even if your youngest claims the AOC for themselves, it is a credit not income

Yeah, it's rather complicated and goofy the way this stuff works.

The AOTC requires spending $4000 out of pocket to get the credit.

I plan to take the AOTC on my return for $4000 in expenses that I paid for their fall semester. They're my dependent, I paid the expenses, and so I am the one who claims the credit on my return.

In order to generate that $4K in OOP spending, I have to make $4K of their scholarships taxable. See the part of Pub 970 starting at the bottom of the first column of page 16 (https://www.irs.gov/pub/irs-pdf/p970.pdf). These taxable scholarships are reported on the student's tax return, not mine.

Thankfully this kid happens to have plenty of scholarships of the right type and qualified educational expenses that qualify for this "make $4K of scholarships taxable" maneuver to work.

 

[SecondCor521]

I just thought of something else. If you do a web search for “Bogart tax tools” you will find a page with multiple links to tax-related calculators. The Education Credits calculator takes a little bit of effort to learn, but is very powerful. There is an optimization function that lets you pull a lot of levers to come up with the best way of allocating payments. (Hint: to get the optimizer to work, you have to include a number for living expenses beyond room & board paid to the school)

Yep, I know about the Bogarts optimizer. I agree it is powerful. I think I optimized everything as well as I can already. I was a bit put off by the complexity of the inputs when I looked at it last. But I'm keeping it on my list for future years since I basically have two college sophomores at this point (DS21 and DD19).

ETA: Taking another look at it now. Should be doable since I have pro forma returns for me and this child.

 

[Philliefan33]

I get it now. It’s not that the AOC itself is income, it’s the parts of the scholarship that you have to make taxable to get the AOC.

Does making a deductible IRA contribution equal to the McDonald’s wages bring any relief?

 

[SecondCor521]

^ Right.

And thanks for the suggestion. The problem's already solved (see last paragraph in post #3). But the problem I was facing had to do with Chart B limits, so a deductible IRA contribution wouldn't have affected that I don't think. Chart B is mostly based on gross income, and a deductible IRA comes after that in the tax process.