Who should claim a dependent student for greatest overall tax benefit?

May 4, 2011

A reader asks…

“I am in a long-term same sex relationship with civil union in NJ.  We have a child in college.  I make about $150,000 annually, and my partner makes about $60,000.

I filled out the FAFSA application last year for student loan application before my child started college.  Based on my income, I received no education credit this year for my child’s education expenses.

My question is, can my partner fill out the FAFSA application for our child this year and claim head of household and the education deduction for 2011?  I believe there might be a better tax benefit for our family by her doing so.” (Paraphrased to remove identifiable details that do not affect the tax treatment.)

I’ll begin by pointing out two things. First, I’m no student aid expert, so anything I say related to FAFSA or financial aid should be verified with somebody more familiar with the rules of the Department of Education in this regard. Second, you’re actually asking two questions, because as we’ll see, claiming Head of Household is not necessarily the same thing as being the parent for FAFSA purposes.

I did a little research into the FAFSA rules about who is the “parent” for FAFSA purposes. And here’s what I found at this summary from the Department of Education website:

  • Since you’re not considered “married” by your state, FAFSA should be completed as if you are divorced. (Nice, huh?)
  • The divorced rules say the parent is the one who the child lived with the most in the previous 12 months.
  • If a child lives with each parent “exactly six months”, then the parent for FAFSA purposes is the parent who provides the greater financial support.
I would assume (see earlier note about not being an expert), that in your situation, the parent for FAFSA purposes is the one who provides the greater financial support since the child lived with you both an equal amount (all year). Of course, the assumption would generally be that the one with higher income provides greater financial support. But now I’ll explain, as I turn to the tax ramifications, how this may not necessarily be the case.

For tax purposes, it’s generally better for a parent with higher income to claim the dependency exemption for a child. Of course, there are exceptions to this general rule. Because of the value of the American Opportunity Credit, and the fact you are disallowed this credit while your partner would be able to claim it, your situation is likely one of the exceptions. (Of course, you’ll have to run the number both ways to know for sure.)

Be aware that even if it is in your best interest for your partner to claim the exemption for your child, there are a variety of rules that come into play in determining who can claim a dependent in various situations. Assuming your child lives with both of you in your shared home all year (ignoring temporary absences for school), then your situation is governed by the rules spelled out on Page 14 of IRS Publication 501 under the heading “Special Rule for Qualifying Child of More Than One Person.” The relevant rule for this discussion is the fact that whoever claims Head of Household for the child is the only one who can claim nearly all other credits and deductions for expenses related to the child.

The person who claims Head of Household must be the one who provides more than half of the “household support” for the household where the qualifying child lives. Conveniently, Publication 501 provides the following simple worksheet to help you determine who is eligible to claim Head of Household:

Notice that it is not necessary for the higher earner to claim head of household, so long as the lower earning partner pays more of the above expenses**. The higher earner can pay for things like food eaten off-site, recreation expenses, even the education costs of the child! (Education expenses are always treated as paid by the student, and the deduction is claimed by whoever claims the exemption for the student.)

So in order to allow the lower earning spouse to claim the child, you’ll need to arrange your spending so that the lower-earning partner provides more than half of the household support. Before doing that, I recommend you make backup copies of your 2010 returns, and then change the filing status and dependents claimed on each return to reflect the lower-earning spouse claiming the dependent, Head of Household, and associated education credits. Because the Head of Household tax rates are much better than the Single rates, it is entirely possible that even though the education credit is lost due to your higher income, you may still be better off filing Head of Household yourself. If your combined tax liability isn’t reduced by making these changes on copies of last year’s returns, then it’s probably not going to improve your tax situation for 2011 either…and you can save yourself the hassle of a lot of record-keeping.

One other item that comes to mind, and I simply don’t have the answer to, is whether FAFSA uses the same definition of “financial support” as the “household support” definition used by the IRS. It seems probable that “financial support” includes items not part of “household support” (e.g. the education expenses paid for the child). So it’s entirely possible that the parent who claims the child for FAFSA purposes is different from the parent who claims the child on the tax return. You’ll have to consult somebody more familiar with student aid.

But I hope this at least helps you understand who should claim Head of Household and the dependency exemption (and associated credits) on the tax return and what the tax ramifications will be.

(**Note: This discussion does not apply to domestic partners/same-sex spouses residing in California, Nevada, or Washington. Those are community property states, and most income and expenses are automatically deemed as being earned 50/50 by each partner and spent 50/50 by each partner. This discussion would go very differently for same-sex couples in those states.)