How to save on taxes when your college grad moves back home

Qualify for the dependent exemption and deduct $3,800 from your earnings

Brandon Lafving
by Brandon Lafving, IRS contributor (@TechDragoon)

 

The economy is better than it was, but not ideal, and the job market for recent college graduates is abominable. In April of this year, a devastating report by the AP concluded that 53.6% of young people (under 25 years old) with a bachelors degree were either unemployed or underemployed. Clearly there is a disconnect between traditional baccalaureate programs and the American workplace. BA and BS degrees do not carry the experience or skills that employers need, much less want.

READ: The most common money mistakes made by college students

You are not alone if your kid moved back in with you this summer after graduation. And if you currently have a kid or two in college, then you would be wise to plan for the worst-case scenario – prepare the empty nest to be refilled. That means more than fluffing the pillows. Arm yourself with great advice and proper tax planning.

For one, you might want to consider graduate school, especially if your kid does not have a sincere career plan. The education credits and tax deductions for students that open up with this option are pretty impressive on their own, even without considering your kid's confidence, which could take a hit after living with you for a couple of years of their "adult" life.

But if your child already moved in with you, this year or last year, then you need to know the ground rules for claiming the graduate as a dependent on your tax return and for receiving the maximum benefits.

READ: Schools that get their grads the highest starter salaries

If You Cannot Claim a Child Dependent, Go for the Relative Dependent Instead

You can claim a child dependent as long as your kid remains a full-time student for at least 5 months of the tax year. This means that if your child graduated in June, 2013, you can claim them as a child dependent on your 2013 tax return. After that initial year, however, claiming the deduction becomes slightly trickier.

You will need to claim the student as a qualifying relative instead. Children do not even need to live with you to qualify as a dependent relative. You do need to provide more than half the total support, so only one divorced parent will be able to take the deduction. But the real problem is most often income.

Qualifying as a relative dependent limits your child to at most $3,800 in gross income for the year. Although I personally find this limitation prohibitively low, for now it is what you have to deal with. If your kid will earn close to that figure, take your tax savings into consideration. A $3,800 deduction is worth roughly $950 to you (with a 25% effective tax rate).

READ: Tax advantages of a 529 college-savings plan

And keep in mind that your kid still counts toward your Earned Income Tax Credit as long as he/she lives with you for at least half the year. Each child can result in substantial additions to the maximum credit available.

Qualifying for the Earned Income Tax Credit is unrelated to qualifying for the tax deduction.