Q. Are there certain things he can't pay for?
A. Simple answer: No. At least for income taxes and dependent status purposes. There are limits for purposes of gift tax return rules*. If the money Grandfather has set aside is in a 529 Plan, then there is no limit on school related expenses.
Q. How will that affect our claiming our son as a dependent?
A. Not at all. He can still be your dependent. There are two types of dependents, "Qualifying Children"(QC) and standard ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test.
The support test is different for each type. The support test, for a QC, is only that the child didn't provide more than half his own support. The support test for a Qualifying Relative is that the taxpayer provided more than half the relative's support.
A child of a taxpayer can still be a “Qualifying Child” (QC) dependent, regardless of his/her income, if:
- He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
- He did not provide more than 1/2 his own support. Scholarships are excluded from the support calculation. So, since your son won't be providing his own support, the relative he lives with (you, his parents) can still claim him, even though Grandfather is providing most of his support.
- He lived with the parent (including temporary absences such as away at school) for more than half the year.
Because he is your dependent, you get to claim the tuition credit or deduction, not Grandfather.
*The tuition gift tax exclusion only applies to tuition payments. Money that is gifted to a child for other college expenses, such as books, supplies, room and board costs, do not qualify for the exclusion.
