Deductions & credits

Does he need to file in Illinois and NY tax returns?  Yes, he will need to file for both IL and NY.  He will need to file a nonresident return for IL because this is the physical location where he earned the money.  He will then have to file a resident return for NY because this is his permanent home state

Does she need to file in Massachusetts and NY tax returns?  No, since the internship was physically performed in NY, she would only need to file a NY return UNLESS she has a job while she away at college in MA.  

Can we still claim them as our dependents? They are full-time students and we are paying his tuition.  Probably.  As long as they meet the following criteria, you can claim them as dependents even if they are working while in school. 

The following criteria must be met to claim someone as a qualifying child:

• Your child (including adopted and foster children), your sibling, or a descendent of any of them.
• Age 18 or younger at the end of the tax year OR under 24 (and younger than you and your spouse) if they are a full-time student
• Lived with you for more than 6 months during the tax year, temporarily away at college counts as living with you
• They did not provide more than half of their own support
• They did not file a joint return, unless it was to claim a refund

Since they are over 17 you would be able to claim the $500 Non-Refundable Other Dependent Credit for each of them if they meet the above.  You may also be able to claim the American Opportunity Tax Credit or the Lifetime Learning Credit depending on type of education they are working on and how long they have been in school.

Is he required to switch to IL DL to file his income tax next year? He planning to return to NY in 2 years...If he is not becoming a resident of IL, then no, he would not need to switch his drivers license to file a return.  If he does become one, IL does require the DL or photo ID info to e-file your return.

Tax Benefits for Education