This is the time of the year when that first semester of college tuition is due. Where can parents find help in the tax system?
SALARIES TO THE STUDENT
If the student is working on the farm for some part of the year, compensation can be a great tool. The student's salary isn't subject to income tax until it exceeds the standard deduction ($6,300 for 2016). Normally, there will be the 15.3% Social Security tax on the salary, except in the case of a parent/proprietor paying a child who has not attained age 18. The key to withstanding IRS scrutiny is documentation. The IRS won't accept general verbal assertions regarding the labor provided by the child. Rather, you should maintain notes of dates and hours worked, just as you do when that neighbor kid provides extra help. If hours are tracked and a reasonable rate of pay is used, this is an exceptionally tax-efficient method for paying some of the college costs with pre-tax dollars.
GIFTS OF GRAIN
Unsold grain is moved as a gift to a child, who later sells it in a lower tax bracket and without self-employed Social Security tax (because the student isn't conducting a farming business). But "kiddie tax" applies until the 24th birthday of the student, imposing the parents' top tax rate on the child's income from this source. There will be some SE tax savings to dad, but if the parents' return is in the upper tier 2.9% or 3.8% SE tax rates, the savings are minor and perhaps not worth the compliance hassle of the kiddie tax. The kiddie tax does have a small $2,100 annual exemption, so those who start early with grain gifts can build an accumulation.
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TAX CREDIT AND DEDUCTIONS
During tuition-paying years, taxpayers have three choices: an American Opportunity tax credit, a Lifetime Learning credit, or a pre-AGI tuition deduction. Generally, the most lucrative is the American Opportunity Tax Credit, allowing a $2,500 direct federal income tax offset from the first $4,000 of tuition and fees. This credit may only be claimed in four tax years for any one student, however, so then generally there's a switch to the Lifetime Learning credit. If the student is a dependent, which is normally the case, the parents claim the credit. However, there are differing income phase-out ranges (e.g., in a joint return, the American Opportunity credit starts phasing out at $160,000 of AGI). For higher-income parents, it may make sense to forego a student's dependency exemption, in order to allow the child to claim the benefits of one of these tax credits, perhaps after enhancing the student's income with a grain gift. This is irritatingly complex, and if significant tuition dollars are part of the family equation for 2016, the benefits of these tax credits should be considered at year-end tax planning. The financial aid consequences must also be considered.
SECTION 529 COLLEGE SAVINGS PLANS
Starting early is often the best, and we will discuss this tool and how Congress improved it in next month's column.
Editor's note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years of experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mail AskAndy@dtn.com.
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