Nearly a quarter of all 18- to 34-year-olds report they have moved back in with their parents after living on their own. This may not be every parent’s dream, but those who find their once-empty nest a little more crowded can take heart: Your new housemates may provide you with some sizable tax benefits.
“I think the possibility of getting a tax break makes everybody feel a little better,” says George Jones, a senior tax analyst with CCH, a Wolters Kluwer business. For starters, parents can receive a $3,800 deduction if they claimed their adult child as a dependent in 2012. That potential deduction rises to $3,900 for the 2013 tax year.
Jones notes that there are several tax options for parents of so-called boomerang kids. But to claim key deductions, he adds, you must meet a series of IRS requirements. Your financial advisor and accountant can help you understand the rules for each deduction and determine which apply to your situation.
Who is a dependent adult?
To qualify as a dependent on your tax return, an adult child must fit the IRS definition of either a “qualifying child” or a “qualifying relative.” For the former, the adult child must:
• Be under age 24 at the end of the tax year.
• Have attended school full time for at least five months.
• Have received more than half of his or her financial support from you during the tax year.
The typical qualifying child is a student who graduates from college in the spring and then moves home, Jones says. He adds that the child can even be earning income from a job, as long as the parents still meet the support criteria to claim the benefit.
An adult child who doesn’t meet the definition of a qualifying child might still be considered a dependent as a “qualifying relative.” To be eligible, he or she must:
• Be related to you, though not necessarily a son or daughter (the IRS list of qualifying relatives includes nieces, nephews and even in-laws).
• Have received more than half of his or her total support from you.
• Not have earned more than $3,800 in the year.
The qualifying relative doesn’t have to live with you to be considered a dependent, as long as you are providing the bulk of the financial support and his or her earnings don’t exceed the $3,800 income limit. For example, an unemployed adult who lives in another town and is being supported by his her parents may be considered a qualifying relative.
Jones cautions that parents should claim their adult children as dependents only if they truly qualify. “Otherwise the penalties from the IRS can be quite costly,” he says.
What if I miss the bar?
In some cases, you may not qualify for a dependent deduction. For example, your grown child may have moved back in with you but has a job that pays more than the income limits required to be considered a qualifying relative.
That doesn’t mean you have run out of options. Jones points to a couple of other tax strategies that could provide some benefit for parents as well as for their cash-strapped kids.
Transfer appreciated securities. Using the 2013 gift exemption, parents can transfer up to $28,000 ($14,000 per person) in appreciated securities to their children tax-free. Provided that the children are in the two lowest tax brackets, they could sell the securities without having to pay tax on the proceeds.
Contribute to an IRA. Parents can also make use of the gifting provisions to contribute money to a traditional or Roth IRA for their adult child. In 2013, you can give annual gifts of up to $14,000 to an individual without it counting against your lifetime gift tax exclusion (you and your spouse can give double that amount). The funds can benefit from tax-advantaged growth while giving your underemployed child a head start on retirement savings.
Moving back in with mom and dad may not be in anyone’s master plan, but available tax deductions can make a temporary situation more livable. “The potential reductions are not tremendous,” Jones says. “But consider them anyway. Why leave money on the table when you could qualify for a lower tax rate?”
• This article was written by Wells Fargo Advisors and provided courtesy of Ahwatukee financial adviser S. Kim DeVoss, CFP®. Reach her at (480) 940-5519. Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE. Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.