Wednesday, May 28, 2014


I previously posted a series on how my clients were screwed by the US Tax Code during the tax filing season.  I now begin a series of posts on items, most good for my clients, that came up this year during the tax filing season and on GDEs.

Let’s start with a state tax issue.

The IRS, per IRS Field Service Advice FSA 200236001, permits parents with a dependent child in college, but whose AGI is too high to be able to claim the American Opportunity Credit (AOC) on their Form 1040, to elect not to claim the student as a dependent, and thus allow the dependent student to claim a non-refundable AOC on his/her tax return to wipe out any federal income tax liability. 

Here is how it works –

James Q Taxpayer, the son of John Q and Jane Q, was an unmarried full-time college student who had net taxable income for the year. John and Jane were entitled to claim James as a dependent.

During the year, James incurred expenses that qualified for the AOC. However, John and Jane's Adjusted Gross Income (AGI) was in excess of the maximum AGI threshold, and could not claim the credit.

James' tax liability, before any credits, was more than the amount of combined federal and state tax savings John and Jane would have realized by claiming James as a dependent.

John and Jane, although entitled to, did not claim James as a dependent on their 1040. James filed a tax return, but did not claim an exemption for himself. James did, however, claim the AOC on his return, which brought his tax liability to “0”.  None of the credit claimed on James’ return was refundable.

The original IRS proclamation involved the HOPE education credit – but, as the AOC has replaced the HOPE credit, it applies to the AOC as well.  And I also expect it applies to the Lifetime Learning Credit.

What about the corresponding state returns?  Since John and Jane did not claim James as a dependent on their Form 1040 can they claim him as one on their state returns?

In my practice I deal mostly with NJ state returns, and occasionally with NY state returns.  This year I had a client in this situation who worked in NY but lived in NJ, so the answer was needed for both NJ and NY returns.  FYI, my clients were victims of the dreaded Alternative Minimum Tax (AMT), so they would receive no tax benefit from claiming their college student son as a dependent.

The instructions for the NY state non-resident and part-year resident return, Form IT-203 (and I expect also for the IT-201 resident return), tells us (highlight is mine) -

Also enter the required information for any dependent for whom you were entitled to claim an exemption on your federal return but chose not to (see Example below). If you did not have to file a federal return, enter the required information for each dependent for whom an exemption would be allowed for federal income tax purposes.

Example: You were entitled to claim your daughter as a dependent on your federal return but chose not to in order to allow her to claim a federal education credit on her federal tax return; you may still claim her as a dependent on your New York State return.”

So my clients could claim their son as a dependent on their 2013 Form IT-203.  The clients were also able to claim $10,000 in tuition and fees (the maximum) as an additional state itemized deduction on the IT-203, as their son was an undergraduate (the deduction is not available for graduate school tuition).

What about New Jersey?

Here is what the instructions for the NJ-1040 say (again, highlight is mine) –

You may claim an exemption for each dependent child who qualifies as your dependent for Federal income tax purposes”.

While the NJ instructions do not specifically address the situation, as the NY instructions do, one can imply that my clients’ son can be claimed as a dependent on their NJ-1040 because he “qualifies as {their} dependent for Federal income tax purposes”.  The instructions do not say he has to actually be claimed as a dependent - just that he qualifies - which he does.

Good news for my clients!

I do not know has other states treat this issue – but I would think most do the same as NY and NJ. 

I would appreciate hearing from tax pros in other states on how their state treats this issue.


1 comment:

Indy Taxman said...

This is very interesting, that the states of NY & NJ would allow the claiming of an exemption not claimed on the 1040. In my home state of IN, we have a very simple state adjusted gross income tax. It starts with the Federal AGI, and allows only the exemptions that were claimed on the 1040.