Can I claim him as a dependent if I gift him money?

[loghound]

Hi All

First let me say I've been pretty impressed with the quality of answers to some very specific tax questions.  Having said that here is my very specific tax question.

I have a 21 year old full time student who lives away from home (he is home occasionally like major holidays and perhaps a month or so over the summer but mostly lives at school). Because he lives away from home, is over 18 but is a student I think the only test for 'is he is a dependent' is the support question "Did he provide 50% of his support"

The IRS has a handy worksheet here for walking through it. The part I don't understand is how to handle gifts.  

Her is an example (numbers made up to illustrate the point)

His Income & assets

He works during the summer (and part of the school year Let's say he makes $17,000 a year) and has a taxable brokerage account in his name that was set up to fund his education when he was very young by some generous grandparents (let's say it's worth $50,000 right now)

Let's say my wife and I gift him $25,000 this year ($12.5k each) 

the total money he has access to is

• $25,000 from gifts from mom & dad
• $17,000 from earned income
• $50,000 in a taxable brokerage

His expenses for purposes of the determining support are

• $40,000 in tuition (he has a scholarship of $15,000 and so only pays $25,000 but the total before scholarship is $40,000 so I think you have to use that on the worksheet)
• $15,000 in rent/utilities/books/food/gas, etc "day to day" expenses
• $10,000 in recreation, travel (mostly playing golf probably!)

Expenses Mom & Dad still pay add up to $4,000 a year

• $1200 for car insurnace
• $800  for various family plans (e.g. cell phone, access to the family Netflix account, that kid of thing)
• $2000 as part of family vacations he joins us on
• He has a room here but only stays as a visitor (thanksgiving) and a month or two over summer.  I don't think I need to include this?

So the total cost of his support is $40,000 + 15,000+ $10,000  + mom & dad support ($4000)= 79,000 a year

using the worksheet above (or using the IRS tool for determining claiming dependents) it means if  he pays 50% of  79,000 or $39,500 then is can NOT be claimed as a dependent but if he pays $39,499 then he CAN be claimed as a dependent?

So far this is all pretty clear -- My question is this: If he spends his earned income ($17,000) and pays the entire tuition ($25,000) he would spend $42,000 and be above the $39,500 and so therefore would NOT be a dependent.

If, however, he pays the same $17,000 from his income but mom and dad just pay the tuition directly of $25,000 then he would NOT be a dependent since he only paid $17,000.

In both cases the amount of Money Mom & Dad is the same -- The difference is how the $25,000 was used, as a gift or paid directly to the school.  

The difference is in one case he is gifted his money and the parents hope he makes 'good choices' and uses it for school (but he's not required to) -- He has a sort of free will on spending it. In the second example he had no free will on tuition -- Mom & Dad just paid it.

I think I have this correct but I'd appreciate any feedback..

[Opus 17]

First, you’re reading the qualifications wrong.

For your own legal child under age 24 (biological, step, or adopted) they must live more than half the year in your home and not provide more than 50% of their own support, and be a full time student.

Most of the time, being away at school is considered a temporary absence and the child is considered to live “at home.”  This seems particularly true in your case if the child returns home for summer, and if it is likely that they would return home after graduation, and they still keep stuff at your house. They would only be considered to have moved out if they have made a permanent move away from your home, such as they have moved into an apartment with a romantic partner, or gotten married, or taken some other step which definitively makes them no longer part of your household. 

Now as to the question of “did the child provide more than half of their own support“, support is all the money that is spent to provide for the child‘s living expenses.  Money spent on support includes money spent for tuition, rent, food, clothing, travel, entertainment, and medical costs.  Money spent on support does not count assets in the bank, nor does it count support spent for other people.  For example, if the child has $100,000 in an investment account and withdraws $5000 to pay their own rent and $10,000 to pay for the food, clothing, and other expenses of their live-in romantic partner who does not have a job, then the child has only spent $5000 on their own support, regardless of money spent on other people’s support or money in the bank.

Scholarships and grants do not count as support paid by anyone, for purposes of this calculation. Tuition paid for by a loan in the student’s name is considered support that the student pays for themself, since they are obligated to repay the loan, while tuition paid for by a parent or parent loan counts as support paid for by the parent.

A gift to the child counts as support if the child uses it for living expenses but does not count as support if the child puts it in their IRA for retirement or uses it for something other than their own living expenses.

You include the value of room and board that you provide to your child as expenses that you pay for, using a prorated share of your mortgage, food, hazard insurance, utilities, and other household expenses based on the number of people living in the home.

I hope you can see where this is all going.

Because of the high cost of college, and the general low income of most college students, it is much more common for a child student to be a dependent, and it is uncommon for the child to pay more than half their own expenses so as to not be a tax dependent.  

From your math, the child has $50,000 of expenses “on their own” plus another $5000 or so that you provide indirectly.  Your child spends $17,000 of their own income on their support. The value of the investment fund is irrelevant unless the child withdraws money from the investment account to pay their living expenses. I don’t see any other money from the child going toward the child‘s expenses.  So it seems as though the child does not pay more than 50% of their own support.

However, you may want to re-analyze the situation using the principles I outlined above.

[Bsch4477]

Note that scholarships do not count when determining how much support was provided by the child.

That aside, you should pay for his tuition and if he paid it himself, consider that you just gave him the money to do that. Not only does that satisfy the support qualification, but as your dependent you can claim the American Opportunity education credit if otherwise eligible. 

[Carl]

There's no question as clarified in other responses, the student is your dependent. But to clarify a few things.

1) The program will ask you about support. The program asks you if the ***STUDENT*** (not you) provided more than half of their own support. So make sure you answer that question *NO*.

2) There are only two possible ways the student can provide more than half of their own support.

   A. The student is self-employed or has a W-2 job that pays them enough money throughout the entire tax year to justify and substantiate a claim that the student provided more than half of their own support. The money earned by the student has to be more than the total amount of grants, scholarships, 529 distributions and any other 3rd party income received by the student, or received by the school on behalf of the student.  (Your gift could be considered 3rd party income, since anything you pay towards the student's education and support is considered 3rd party income to the student.)

 B. The *student* (not you) is the *primary* borrower on a qualified student loan, and sufficient funds were distributed from that loan throughout the tax year to justify and substantiate a claim that the student provided more than half of their own support. The money distributed needs to be more than the total of all grans, scholarships, 529 distributions and any other 3rd party income received by the student, or received by the school on behalf of the student.

Nutshell: all moneies received by the student, or by the school on the student's behalf from 3rd parties *do* *not* count for the student providing their own support.

While definitely not unheard of, it's not common for an undergraduate student under the age of 24 on Dec 31 of the tax year, to not qualify as a dependent on someone else's tax return - usually the parent(s).

Scholarships - used for the qualified education expenses of tuition, books, and lab fees. That's it. No exceptions. (Though "lab fees" is a rather broad expense category.)

Grants - same as scholarships unless the grant letter specifies otherwise.

529 Funds - Same as scholarships, but can also be used tax free to pay for the "unqualified" but allowed expenses (emphasis mine) of room and board, provided that room and board is in direct support of the education. So if 529 funds are used to pay for room and board during the summer semester, yet the student is not enrolled for the summer semester, then the 529 funds used for that time frame are not tax free.

Room - In addition to rent, it also includes the cost of utilities (gas, water, electric, etc.) If living off campus, cost claimed can not exceed what it would cost to live on campus. If the student has a letter for each semester, indicating that on campus housing is not available then this restriction is lifted. But even with a letter, costs must be reasonable. (No $5K/mo penthouse suites)

Board - The cost of food. If the school offers a meal plan, then cost claimed for this can not exceed the cost of the meal plan per semester. If student lives off campus *and* has a letter for each semester that on campus housing is not available, then that restriction is lifted. However, costs must be reasonable. (No steak & lobster for lunch and dinner every day.)

[loghound]

First of all let me say "wow" and thank you for the very clear  responses from @Carl @Bsch4477  and @Opus 17 

I had poured over IRS documents, FAQ's, etc. and I made two mistakes

• School is considered 'temporary' if they come home, even if they spend most of their time at school. (I guess if you remodeled their room to be a gym and put their stuff in storage, and all of their mail went to their school address you could argue they were not living at home but in the typical situation college kids are considered living at home if they come back to it in the usual way)
• Handling of Gifts -- I was stuck on how the test for 50% was worded "did he provide 50% of his own support" and thought "well, if we gifted him the money and he used it to support himself then I guess he did" but as you have pointed out the practical effect of gifting him money to live is he really didn't provide it.

This all sort of makes sense to me intuitively as a kind of 'common sense' reading of the tax code.

As an thought experiment if we had gifted him $10,000 at birth and that was used to buy Apple stock in a  custodial brokerage account that would be worth $4.5M today and then we said "hey you could afford whatever you want go for it" and didn't give him any support and remodeled his room to be a home Gym then he could be a student under 24 who is not a dependent because he would be spending his money for support and didn't have a room at our house any more.

Anyway thanks -- you guys have been super clear and helpful

[Carl]

As an thought experiment if we had gifted him $10,000 at birth and that was used to buy Apple stock in a custodial brokerage account that would be worth $4.5M today

Now that's a good question I'd like a definitive answer to. Don't see it much; at least I've never seen such a scenario. But never say never.

Keep in mind that IRS Pub 970 is for the education stuff, and really doesn't get into the detail of what qualifies as a dependent. There's a completely unrelated and separate publication for the dependent stuff:  IRS Publication 17. 

Checking Pub 17 I can't find anything that comes even close to what you describe. However, here's my thoughts on it.

If the account is a "custodial" account, meaning that the child does not have direct control of it, I would interpret that as 3rd party income - even if the student is the one reporting gains/losses on their own tax return.  As for other scenarios where the child obtains sole and full control at say, the age of 18, the IRS pub addresses earned income and borrowed money. It does not address investment income for the purpose of determining dependent status; particularly when the initial cost basis of the investment comes from a 3rd party. Hopefully, someone more knowledgeable on this can jump in, and they may even be able to cite a tax court case or two? I don't know.

[Opus 17]

@Carl 

@loghound 

I don’t think it’s a difficult thought experiment at all. The question is always, can the child be claimed as a dependent on a particular year’s tax return.  If you gave the child a large sum of money in 2021, and nothing in 2022, and they paid their 2022 tuition and living expenses from their savings, then you did not support them in 2022, even though their savings includes the gift from 2021.

(Of course, there may be other reasons to not give a child a large sum of money as an unconditional gift.)

[Carl]

then you did not support them in 2022, even though their savings includes the gift from 2021.

But the question asked, is "did the student provide more than half their own support".  It's not asking if you or anyone else provided more than half of their support.

Now Pub 17 does address earned income. But it doesn't address investment income as a method of one providing their own support.

On top of that, I'm looking at Pub 17 on page 30 "Support Test (To be a qualifying child)". In the first example, it reads, " He (the student) has a part-time job and provided $6,000 to his own support." That's all I have to go on.

What I also note in the above, it doesn't say the student earned $6,000. Only that they provided $6000 towards their own support. The student could have earned $100,000 and still only have provided $6000 to their own support.

BTW - If it sounds like I'm in disagreement with you, I'm not. Just looking for clarification/interpretation is all. Maybe I'm borderline "devil's advocate"? 🙂

[Opus 17]

If the money came from investments or savings that the student owned, it’s the student’s support.  Look at table 2 in IRS publication 501.  Lines 1 through 5 address support the student provided themself. It includes looking at the child‘s savings account balances at the beginning and ending of the year, and if you work through a couple of imaginary scenarios, you will see that if the child withdraws money from their own savings account to pay their expenses, that counts as support the child provides themself, but the remaining balance in the savings account is not considered support.  There’s no reason to think that an investment account would fall under different rules than a savings account.  Money the child spends on themself that comes from their own sources is their own support.

Dependency is determined for each tax year. Suppose the parent gives money to the student in 2021, which of the student puts into a savings account.  It becomes the student’s own money.  Suppose the student then withdraws the money in 2021, a few days or weeks later perhaps, to spend on tuition or rent or other support.  I think it is not correct to consider this money that the student provided themself, because it is clearly money provided by the parents, even if it made a brief stopover in the child‘s bank account.  (We can also look to the IRS view on substance over form.)

Now, suppose the parent gives money to the student in 2021 which the student puts in their savings account. Then in 2022, the student withdraws the money to pay for tuition, rent, or other living expenses, but the parent provides no additional funds in 2022.  Since the student paid their 2022 living expenses from their own funds and the parent provided nothing in 2022, the child would not be a dependent in 2022.

[Carl]

@Opus 17 thanks.