Give Me a Break!

Taxes are going up. You can take that to the bank (or maybe you can't!). This and future administrations will need to pay for existing programs and deficits and new ones that are layered on. That is, of course, unless fiscal prudence comes back into vogue. Here's a tax break that every parent of a school aged child should know about and a way to take advantage of it even for high earners. Writer Bill Bischoff of SmartMoney gives us the refresher on the The American Opportunity credit for 2009.

If you earn a healthy income, then you probably don't qualify for the higher-education tax credits intended to help pay college-tuition bills. However, your college-age child just might.

Both the American Opportunity credit (maximum $2,500 for 2009) and the Lifetime Learning credit (maximum $2,000) help soften the cost of postsecondary education. The American Opportunity credit is available only for the first four years of college, while the Lifetime Learning credit can be used at any time and doesn't have a degree or workload requirement.

Unfortunately, you can't take both credits for the same student in the same year, and many parents earn too much to be eligible for either one. That's because in tax year 2009, the American Opportunity credit is phased out starting at an adjusted gross income, or AGI, of $160,000 for joint filers and $80,000 for unmarried individuals. At AGI levels of $180,000 and $90,000, respectively, the credit is completely phased out. The Lifetime Learning credit is phased out starting at AGI of $100,000 for joint filers and $50,000 for unmarried individuals.

At AGI levels of $120,000 and $60,000, respectively, you're completely ineligible.

As you might imagine, plenty of parents fall into the phased-out category. But even if you're among them, these valuable credits may not have to go to waste after all.

Here's how: Arrange things so your college-age child can claim one of these credits instead of you. To implement this strategy, you must forgo the dependency exemption deduction for your child ($3,650 for the 2009 tax year). Then the education tax credit becomes the property of your child, whose income is presumably well below the phase-out range.

The now-liberated education credit can cut your college-age child's tax bill by quite a bit. Remember, however, the credit is worthless to your child unless he or she has enough taxable income to actually owe the IRS. This income could be from summer jobs, work-study at school or income and gains from investments held in your child's name.

Also, keep in mind that this strategy makes the most sense when your AGI is quite high. Why? Because your dependency write-off for your college kid is itself partially phased out between an AGI of $250,200 and $372,700 for joint filers and between $208,500 and $331,000 for heads of households.

So giving up that dependency deduction on your 2009 tax return may not cost you all that much. (This strategy does not permit your child to claim an exemption on his or her return; the exemption belongs to you whether you choose to use it or not.)

As always, see your planning or tax professional for details and application.