Finally, college graduation day has come!! You probably did not get to experience graduation day the way that you imagined it. Whether you watched your graduate receive their diploma at a drive-thru ceremony or it came in the mail, it is no less of an accomplishment for you as a parent and you as a graduate. As parents and graduates look to the next steps of full-time employment, moving out, and beginning to deal with student loans, both parents and graduates should think about taxes.
Consider the need to adjust your withholding at work. For every dependent on your tax return, you receive the Child Tax Credit or the Dependent credit. The Child Tax Credit is up to $2,000 per child under the age of 17, and the Dependent Credit is up to $500 for any dependent over the age of 16. Since many graduates return home for a period of time after graduation while looking for full-time employment, many parents can take the Dependent Tax Credit in the year their child graduates from college. Parents need to be aware once the child provides more than one- half of their own support, you are no longer entitled to this credit. Support includes food, utilities, repairs, clothing, education, medical, travel, and recreation expenses. IRS has a support test worksheet to assist with figuring out who provided one-half the support available on IRS.gov. If the child provided more than half of their own support, the parents are not entitled to the Child Tax or Dependent Credit. It does not matter where the child lived, support determines if the parent claims the child.
Another important point to consider is the Education Credit or the Tuition Deduction that you probably have been claiming on your tax return. The Education Credit is up to $2,500. The Tuition Deduction reduces your income by up to $4,000. It is important to remember the Education Credit goes with the student. Take Sam & Carol who are divorced with one child, Melissa. Sam and Carol have agreed to alternate claiming Melissa every year. Even though Melissa’s primary residence is with Carol, the years that Sam claims Melissa as a dependent would also entitle him to claim the Education Credit. If the child claims their own dependency in the final year of college, they get the Education Credit.
Without the Dependent Tax Credit, Education Credit, and/or the Tuition Deduction, do you know what your tax refund or balance due will look like? Many people forget about these until their tax preparer gives them a shock of a much smaller refund or much larger balance due than expected. How do you ensure you are prepared after your child graduates? Start by looking at your tax return.
Look at your last tax return. If the Dependent Tax Credit, Education Credit, or Tuition Deduction were removed from your tax return, would you owe money or have a refund? If you do not like the answer, it may be time to make a change. To make that change adjust your withholding at work by submitting an updated W4 form. You can get this form from your employer or at IRS.gov. IRS also has a calculator tool to help you fill out the form on their website.
Graduates need to fill out a W-4 Form as they obtain employment. It is important that you have the appropriate amount of withholding whether you have a full-time job, part-time, and especially important if you have more than one job. The amount of taxes due on your income is different if you are being claimed on your parents’ tax return as a dependent or if you claim yourself as a dependent. If you are living with your parents, it comes down to who provided 1/2 of your support during the year. When you file your tax return and you are a dependent on your parents’ tax return, your standard deduction significantly lower than when you are no longer a dependent. This may mean you need to change your W4 now at your current employer. Your employer will provide you with the form when you are hired or if you need to make a change to your current withholding. You may go to IRS.gov to use their calculator tool to see how much you should have withheld based on what you will earn. Having the correct amount of withholding when you begin your employment should mean that you do not see a large balance due at tax time.
Many people over withhold on their paychecks to get a larger refund. Since many graduates come out of college with some student loans, you may not want to do this. Student loan payments begin six months after you graduate. If you over withhold from your wages, you will have less money in your pocket to cover living expenses and your new student loan payments.
Another consideration for those who have student loans is to begin paying the interest on the loans while in school or before the 6-month grace period is over. By paying the interest now, you will pay less over the course of the loan as interest is not accruing. This can significantly reduce the burden on your budget when you get out of school and begin establishing your own way since monthly payments would be lower. By starting payments earlier than six months, your balance would be less. This allows for your monthly payments to be less when the payment amount is determined by your lending institution.
Taxes are complicated for many people; remember, you can always contact your tax preparer to help fill out your W4 form. It is always better to deal with and stay ahead of your taxes than to deal with it later. This can be costly!