Back Door AOTC [American Opportunity Tax Credit]

[986racer]

I've been posting this on a few different threads and I thought I'd put the info into this one thread so that others can debate the merits of this strategy here.

What is AOTC
AOTC is short for American Opportunity Tax Credit. It provides a $2500 tax credit for each of four years of the community/undergraduate education. Even if you have no tax liability, you might still be eligible to receive a portion of the $2500 credit back in what's called refundable credits.

What are the income phaseouts
The credit starts getting phased out at 80k (single) or 160k (MFJ). It's fully phased out at 90k (single) or 180K (MFJ)

I'm over the phase out limit. What can I do?
The rest of this covers this question. Similar to a back door Roth, the idea of the back door AOTC is to provide the AOTC benefit to your family but it requires a circuitous route to do so.

The basic idea works like this: while you personally are not eligible for the AOTC because of the income limits, your student might be. However, your student cannot claim the credit if you claim the student as a dependent on your return. So, first off, you need to not claim the student as a dependent. Note, it doesn't matter that you are eligible to claim the student, simply do not claim the student.

Next, with rare exceptions, your student will only be eligible for the non-refundable portion of the AOTC. This means that your student will need tax liability of at least 2500 (line 24 of the 1040) to take full benefit of the AOTC. For most students with part-time jobs, getting 2500 of tax liability via earned income is difficult because the standard deduction is so high.

In order to achieve $2500 of tax liability, the student will likely need to do it via unearned income. This is where "kiddie tax" can work to your benefit. If you have stock in a taxable account that has gains in it, gift that stock to the student, and then have the student sell the stock, and then use the proceeds to pay the tuition bill. The "kiddie tax" will have that stock sale be taxed at your tax rate and the resulting sale will generate tax liability.

For those who are worried about gifting stock to a child, you can wait until the last minute to gift this stock. E.g., if tuition payments are due on July 15, you could gift the stock on July 12, sell on July 13, and pay the school on July 15 with the settled funds. If you are still concerned about the funds being accessible to the child for even a day, you may be able to use an UTMA account for this (depending on the age of majority in your state).

How much should you gift and how much LTCG should be in the gift?
Assuming you are married, you and your spouse can each gift 18k of stock, so a total of 36k can be gifted. If you are in the 15% LTCG bracket, you would want at least 19167 of LTCG built up. If you are in the 20% LTCG bracket, then it would be 15000 of LTCG

How does this help?
If you were planning to cash flow college, but you have this appreciated stock in a taxable account, you could gift the stock to your student, have them sell it, and pay the college with the proceeds. You could then repurchase the same stock with the money that you were going to use to cash flow the college payment. This effectively resets your basis and removes the taxable gains from your account.

How does this work with a 529? Should I do this instead of a 529?
This can work in conjunction with a 529. For those who are worried about overfunding a 529, you can partially fund the 529 and then put some money in a taxable account as well. The amount in the 529 is used for the heavy lifting, and the money in the taxable account is used to cover whatever shortfalls are in the 529 account. The provides flexibility so that if the taxable account is overfunded, there is no penalty in using that money for some other purpose.

What about LLC?
LLC is the Lifetime Learning Credit, and very similar to the AOTC, it allows for tax credits as well. These credits are all non-refundable, they provide credit for 20% of the payments (up to 2000 max of credits), but they can be used for any level of college education. Also, while AOTC can be used for only 4 years, most students are actually in school for a total of 5 tax years. So the "back door AOTC" can also be used as a "back door LLC" strategy too for the following scenarios

• 5th tax year of an undergraduate education
• Part of master's degree
• Dual enrollment course from a student's high school

Dependency Definitions and Questions
NOTE: the IRS has a few different definitions of "dependency" that will differ based on what part of the code you are looking at. In some places, a person is considered independent if the person provide over half of their own support. In other places, the dependency test requires that the person supplies over half of the support via earned income. For purposes of the "back door AOTC", neither definition matters. You aren't trying to declare your student as independent. Instead, you merely need to not list your student as a dependent.

EDITED to add how to model this in Turbo Tax
To get Turbo Tax to show the credit, do the following (all on your student's return). Also, as an aside, I was not able to get FreeTaxUSA to handle this correctly. I've reached out to their support team and they admitted that the software does not handle that (my last communication with them was in early 2023)

1. In the personal section, check the box that shows that the student can be claimed as a dependent. You will then get an option, which you should select, that will then list that the student will not actually be claimed.
2. List your income in the "Federal Taxes" tab in the section labelled "Child's Income (Under Age 24)". This is what will trigger the kiddie tax on unearned income
3. List the investment income from the gifted capital gains in "Federal Taxes" -> "Stocks, CryptoCurrency, Mutual Funds, Bonds, Other"
4. Finally, put in the 1098-T information in "Deductions & Credits" -> "Expenses and Scholarships (Form 1098-T)". After you put that in, it should ask you to run something called the "optimizer".

If you do all 4 steps above (make sure step 4 is last), you should then see the credit. If you already tried doing this in TurboTax and missed a step, make sure you complete all of the above, and the redo step 4 after you finish the one you missed.

[Kagord]

Déjà vu moment, when my kids were starting....viewtopic.php?t=187524, if you want some additional discussion on it.

[clobber88]

Please explain how both the Qualifying Child and Kiddie Tax "Support Test"s (two separate and different ones) factor into this plan?

I dont have access to my notes right now (which contain links to the official IRS docs), and I hate to cite "random" Internet links - but I think https://www.thetaxadviser.com/issues/20 ... -2010.html is pretty good if a bit dated. Specifically the section titled "Impact of Dependent Designation," which ultimately says, "If the student provides more than one-half of his or her support, the student qualifies for the above benefits on his or her tax return."

It's the first part of your plan that is tripping me up, and I have not looked at this in a while. It is my recollection that just because you don't claim your child on your tax return as a dependent - which you can clearly do and often has benefits - does not mean they qualify for certain tax credits like AOTC on their own.

[986racer]

Please explain how both the Qualifying Child and Kiddie Tax "Support Test"s (two separate and different ones) factor into this plan?

I dont have access to my notes right now (which contain links to the official IRS docs), and I hate to cite "random" Internet links - but I think https://www.thetaxadviser.com/issues/20 ... -2010.html is pretty good if a bit dated. Specifically the section titled "Impact of Dependent Designation," which ultimately says, "If the student provides more than one-half of his or her support, the student qualifies for the above benefits on his or her tax return."

It's the first part of your plan that is tripping me up, and I have not looked at this in a while. It is my recollection that just because you don't claim your child on your tax return as a dependent - which you can clearly do and often has benefits - does not mean they qualify for certain tax credits like AOTC on their own.

Your last paragraph is the part that needs to be dispelled as the IRS is very clear on this point. Here is the HTML version of the Publication 970 instructions

Who Can Claim a Dependent's Expenses?
IF you... don't claim on your tax return a dependent who is an eligible student (even if entitled to claim the dependent)
THEN only... the dependent can claim the American opportunity credit. You can't claim the credit based on this dependent's expenses.

As to your first question about "qualifying child and kiddie tax", the student won't be eligible for refundable credits unless the student meets the standard of providing over half the support via earned income. This is also the same test to make the child not be subject to kiddie tax.

[986racer]

Déjà vu moment, when my kids were starting....viewtopic.php?t=187524, if you want some additional discussion on it.

Thanks. Looks like almost the same discussion then as now too.

[worthit]

OP thanks for posting details of the Back Door AOTC.

Can this be applied to private grade school education or is this is allowed only for college education?

[jebmke]

OP thanks for posting details of the Back Door AOTC.

Can this be applied to private grade school education or is this is allowed only for college education?

AOTC is for college degrees

[CletusCaddy]

This whole idea of gifting the shares to your adult child and then selling it on their behalf sounds sketchy to me. You would need their permission to do so, correct?

[Katietsu]

OP thanks for posting details of the Back Door AOTC.

Can this be applied to private grade school education or is this is allowed only for college education?

AOTC is only for undergraduate level.

[986racer]

OP thanks for posting details of the Back Door AOTC.

Can this be applied to private grade school education or is this is allowed only for college education?

As others pointed out, AOTC is only for undergraduate. However, LLC can work for any level of college and this includes dual-enrollment courses taken while in high school

That credit caps out at 2k per year

[986racer]

This whole idea of gifting the shares to your adult child and then selling it on their behalf sounds sketchy to me. You would need their permission to do so, correct?

It depends... For my state, the age of majority on UTMA accounts is 21, so I could put the money in there and do all of the work. I think it would be difficult to argue that paying for their college is not for their benefit.

When they turned 22, I explained exactly how this was going to work and they gave me authority on their accounts.

However, yes, it is legally their right to take the money and blow it on something else. I wouldn’t choose doing this strategy if you don’t trust your child. Then again, I probably wouldn’t pay for their college in the first place if I thought this was an issue

[cmr79]

986racer, thanks for posting this. It is certainly something for many of us to consider in college planning.

[Anil]

So, at the end of this exercise, the 2500$ tax credit wipes out the 2500$ tax incurred by the child due to selling gifted stock. Which means the parent basically sold their appreciated stock and paid no tax on it.
The only "loss" here is the excess tax paid by the parent due to not claiming the student as a dependent.

Does this sound about right?

Thanks.

[986racer]

So, at the end of this exercise, the 2500$ tax credit wipes out the 2500$ tax incurred by the child due to selling gifted stock. Which means the parent basically sold their appreciated stock and paid no tax on it.
The only "loss" here is the excess tax paid by the parent due to not claiming the student as a dependent.

Does this sound about right?

Thanks.

That’s basically it. If you are needing to use this strategy it’s quite likely that you weren’t going to get a benefit from claiming the student as a dependent anyhow

[er999]

This strategy is good to know, although if you had put that money in a 529 originally the gains would be tax free already. It isn’t a huge benefit but if you have undersaved in a 529 but have a large taxable account worthwhile to know.

[986racer]

This strategy is good to know, although if you had put that money in a 529 originally the gains would be tax free already. It isn’t a huge benefit but if you have undersaved in a 529 but have a large taxable account worthwhile to know.

That was the situation I was in. However, I had a concern about saving even more in a 529 due to concerns about overfunding it. This ended up providing a lot of flexibility as any extra funds in the taxable just stayed with me.

EDIT: to be clear, I’m not suggesting that this strategy would completely replace a 529 but would be used in addition to it. With current annual gifting limits, the max this strategy will cover is 170k over the 5 years. Private colleges can cost more than that, so a 529 is still useful

[Anil]

So, at the end of this exercise, the 2500$ tax credit wipes out the 2500$ tax incurred by the child due to selling gifted stock. Which means the parent basically sold their appreciated stock and paid no tax on it.
The only "loss" here is the excess tax paid by the parent due to not claiming the student as a dependent.

Does this sound about right?

Thanks.

That’s basically it. If you are needing to use this strategy it’s quite likely that you weren’t going to get a benefit from claiming the student as a dependent anyhow

Hmm... I thought anytime you claimed someone as a dependent, you always received a benefit, tax wise...

[986racer]

Hmm... I thought anytime you claimed someone as a dependent, you always received a benefit, tax wise...

The child tax credit only applies to children under 17, so you wouldn’t use it anyhow for a college aged student.

Similarly, the child care and dependent care credit is for those dependents under 13 years old.

The earned income tax credit has fairly low AGI cutoffs

The TCJA got rid of the automatic credit for having a dependent. So, if you are over the AOTC phaseout amount, I don’t think there is a tax benefit anymore for declaring your student as a dependent on the federal return. There may be some exceptions if you are paying substantial medical bills for them.

On the other hand, you may still want to declare the student as a dependent on your state return. Depending on your state, the dependency status doesn’t have to match the federal status

[erp]

The TCJA got rid of the automatic credit for having a dependent. So, if you are over the AOTC phaseout amount, I don’t think there is a tax benefit anymore for declaring your student as a dependent on the federal return. There may be some exceptions if you are paying substantial medical bills for them.

You'd have to forego the $500 other dependent credit that your student dependent may qualify for. Still worth it if your kid can get the whole AOTC

The TCJA got rid of the personal exemption which starting phasing out at an even lower AGI than the CTC (which is 400k for mfj), but replaced it with a doubled CTC (which is usually worth more) and the other dependent credit (which could be worth less).

[erp]

This whole idea of gifting the shares to your adult child and then selling it on their behalf sounds sketchy to me. You would need their permission to do so, correct?

This forum has the "step transaction doctrine" on speed dial, but for some reason never brings it up in this case. There was even a thread comparing gifting appreciated shares to the grandparents to sell at 0% LTCG and then paying the tuition (no! violates step transaction), vs the current case of gifting same shares to student (sure, fine).

Since there's never been any supporting links to actual IRS notices or anything, it's all just internet conjecture. Most likely would never be an issue anyway, until you get audited for any other reason and they question everything. My guess is that the IRS would win in that argument.

[986racer]

The TCJA got rid of the automatic credit for having a dependent. So, if you are over the AOTC phaseout amount, I don’t think there is a tax benefit anymore for declaring your student as a dependent on the federal return. There may be some exceptions if you are paying substantial medical bills for them.

You'd have to forego the $500 other dependent credit that your student dependent may qualify for. Still worth it if your kid can get the whole AOTC

The TCJA got rid of the personal exemption which starting phasing out at an even lower AGI than the CTC (which is 400k for mfj), but replaced it with a doubled CTC (which is usually worth more) and the other dependent credit (which could be worth less).

My mistake…. I forgot about that one because I am also over the phaseout for that credit.

[986racer]

This whole idea of gifting the shares to your adult child and then selling it on their behalf sounds sketchy to me. You would need their permission to do so, correct?

This forum has the "step transaction doctrine" on speed dial, but for some reason never brings it up in this case. There was even a thread comparing gifting appreciated shares to the grandparents to sell at 0% LTCG and then paying the tuition (no! violates step transaction), vs the current case of gifting same shares to student (sure, fine).

Since there's never been any supporting links to actual IRS notices or anything, it's all just internet conjecture. Most likely would never be an issue anyway, until you get audited for any other reason and they question everything. My guess is that the IRS would win in that argument.

I would suggest for other reasons that it would be good to have each gift come in the tax year before it was actually needed. This will allow the student to show that over half of their support came from them (useful for some other tests - e.g COVID relief)

It should also help alleviate any step doctrine.

With that being said, having the student sell the shares results in the same capital gains being paid due to kiddie tax. This isn’t an attempt to gift to someone in a lower bracket

[LocusCoeruleus]

Can someone explain how OP came up with $19167 for 15% ltcg bracket and $15000 for 20% ltcg. Since 40% is refundable, I imagine one just needs to come come up with enough ltcg to cover the rest and if so no need to file form 8615 since unearned income is less than $2300? Also the above doesn’t take into account NIIT. Finally would parents prior tax loss harvesting with a $3000 carry over and mess up the calculation?

[the_wiki]

Sure seems like fraud to me.

[986racer]

Can someone explain how OP came up with $19167 for 15% ltcg bracket and $15000 for 20% ltcg. Since 40% is refundable, I imagine one just needs to come come up with enough ltcg to cover the rest and if so no need to file form 8615 since unearned income is less than $2300? Also the above doesn’t take into account NIIT. Finally would parents prior tax loss harvesting with a $3000 carry over and mess up the calculation?

0% of the 2500 is refundable unless the student is providing over half of the support via earned income.

Tax loss harvesting doesn't come into play with kiddie tax unless the student has his/her own tax losses. Kiddie tax is handled via form 8615 and it doesn't have a place to list carry over tax losses from the parents.

Similarly, NIIT is an individual thing, and also not affected by kiddie tax. So, the student would need over 200k of MAGI to be affected by it.

The math works as follows. The student's standard deduction is the min(13850, max(1250, earned income + 400)). So, the numbers I was giving was assuming that the student had no earned income and had a standard deduction of 1250. Likely that caused the numbers to be 850 too high. But... let's go with the example of a student who has no earned income and you can subtract 850 if that's true in your circumstance.

So... in kiddie tax. The first 1250 is covered by the standard deduction. The next 1250 is taxed at the child's individual tax rate (so 0% LTCG bracket). The rest is taxed at the parent's tax rate.

So, the formula is basically 1250 + 1250 + ( 2500 / parent's marginal tax rate ).

Let's see how this works out.
If parents are at the 20% LTCG bracket and the student has 15k of LTCG... The first 2500 is tax free. So, we are now down to 12500 of LTCG. At a tax rate of 20%, that is a tax liability of 2500. That tax liability is exactly offset by the 2500 of AOTC.

If parents are at the 15% LTCG bracket and the student has 19167 of LTCG... The first 2500 is tax free. So, we are now down to 16667 of LTCG. 16667 * .15 = 2500.05. That rounds down to 2500 and is also exactly offset by the 2500 of AOTC

[986racer]

Sure seems like fraud to me.

I agree that it feels like a loophole, but fraud is a strong word. Fraud would be the case if the student was claiming AOTC without actually being in school.

The kiddie tax law was introduced in 1986 precisely to address parents giving appreciated stock to minors and college aged children to ensure that the tax on those investments are still recognized. The fact that a law exists detailing exactly how these calculations should be done means that it is legal to gift stock to the children. As far as I can tell, there is no minimum holding period once the stock is gifted.

The AOTC laws make it perfectly clear that a student that is not declared as a dependent is eligible for AOTC. The IRS website basically details out the exact scenario where a parent should not declare the child as a dependent (even if the parent is eligible to declare the child as a dependent) so that the child would be able to take the credit.

The most I could think of is that the IRS could potentially say that even if the child is not declared a dependent, there must still be some gifts given to the child. E.g., child is allowed to stay at home over the summer, can borrow the family car, etc. And those gifts must have value and therefore a gift tax form should be filed. Using that logic, however, letting a true minor (e.g., a 10-year old) stay at your home must also have some value and arguably even more since it is a full year of free living and food. However, nobody blinks an eye if on top of that a 34k payment to a 529 is made. Does declaring someone a dependent somehow allow us to avoid questioning of gift tax limits?

[the_wiki]

Sure seems like fraud to me.

I agree that it feels like a loophole, but fraud is a strong word. Fraud would be the case if the student was claiming AOTC without actually being in school.

Your family is above the limit for the intended tax benefit. You are finding a way to pretend your child has income. The reality is that it is your income that you are funneling through a child's tax return. You are taking money from the IRS that was not intended for you.

You may never be charged with a crime, but it is misrepresentation in order to derive personal gain. That is the very definition of fraud.
.

[986racer]

Sure seems like fraud to me.

I agree that it feels like a loophole, but fraud is a strong word. Fraud would be the case if the student was claiming AOTC without actually being in school.

Your family is above the limit for the intended tax benefit. You are finding a way to pretend your child has income. The reality is that it is your income that you are funneling through a child's tax return. You are taking money from the IRS that was not intended for you.

You may never be charged with a crime, but it is misrepresentation in order to derive personal gain. That is the very definition of fraud.
.

There certainly is no issue with gifting stocks to the children to have them sell it. As I said, that’s the very reason that the kiddie tax laws exist.

The issue you seem to have is about the child taking the AOTC credit. Again, I’d argue that the law is perfectly clear that this is acceptable. It goes into detail about eligibility tests for refundable vs non-refundable credits. It would have been easy for the law to be written that those under age 24 who aren’t providing over half their support via earned income aren’t eligible for any of the credit. I.e., it would have to be a credit taken on the parents’ return. Instead, the IRS gives clear instructions that the student is eligible for the credit so long as the parent doesn’t declare that student as a dependent.

The closest analogy I would have for what you are describing is the strategies that used to exist for SS to claim and then suspend so that the spouse could start collecting.

Those were loopholes and were eventually shut down but they were perfectly legal.

If you said, “shh… this is good but keep it quiet so that Congress doesn’t remove it” then I’d understand. Calling it fraud is a stretch. It’s no different in my mind than back door Roths. In those, people get to avoid future taxes on investments by placing them in accounts that they clearly don’t qualify for.

[the_wiki]

It’s no different in my mind than back door Roths. In those, people get to avoid future taxes on investments by placing them in accounts that they clearly don’t qualify for.

I also think that should be illegal. I hope they close that loophole.

In general, I am against subsidizing the wealthy in any way. But that probably puts me in the minority on the forum.

[cmr79]

It’s no different in my mind than back door Roths. In those, people get to avoid future taxes on investments by placing them in accounts that they clearly don’t qualify for.

I also think that should be illegal. I hope they close that loophole.

In general, I am against subsidizing the wealthy in any way. But that probably puts me in the minority on the forum.

You can be personally or morally against these things, but arguing that using a "loophole" is fraudulent is making a legal argument against them that is unsupported. Personal/moral arguments can be made against explicitly intended application of the tax code as well, but ultimately these types of arguments ("I don't like this, so you shouldn't use it and it shouldn't exist/should be changed") aren't helpful for actionable advice and tend to devolve into policy speculation.

[the_wiki]

It’s no different in my mind than back door Roths. In those, people get to avoid future taxes on investments by placing them in accounts that they clearly don’t qualify for.

I also think that should be illegal. I hope they close that loophole.

In general, I am against subsidizing the wealthy in any way. But that probably puts me in the minority on the forum.

You can be personally or morally against these things, but arguing that using a "loophole" is fraudulent is making a legal argument against them that is unsupported. Personal/moral arguments can be made against explicitly intended application of the tax code as well, but ultimately these types of arguments ("I don't like this, so you shouldn't use it and it shouldn't exist/should be changed") aren't helpful for actionable advice and tend to devolve into policy speculation.

Fair enough. I'll refrain from commenting further.

[slicendice]

I agree this is definitely not fraud, and seems like it is allowed by the tax code. If doing a backdoor Roth is legal, I see no reason not to do this. All of these are explicitly codified: Gifting stock to kids allowed, not claiming kids as dependents allowed, kids paying kiddie tax on stock gains is required, kid claiming AOTC on tuition payments kid makes is allowed if kid is not claimed as dependent by someone else. In terms of "loopholes" in the greater scheme of things this is pretty small potatoes compared to other widely publicized things that have a strong lobby to ensure they remain loopholes.

[SchruteB&B]

This forum has the "step transaction doctrine" on speed dial, but for some reason never brings it up in this case. There was even a thread comparing gifting appreciated shares to the grandparents to sell at 0% LTCG and then paying the tuition (no! violates step transaction), vs the current case of gifting same shares to student (sure, fine).

Since there's never been any supporting links to actual IRS notices or anything, it's all just internet conjecture. Most likely would never be an issue anyway, until you get audited for any other reason and they question everything. My guess is that the IRS would win in that argument.

Step transaction is what came to my mind. And agreed, it will likely never be an issue but if it does become one, my guess would also be that the IRS wins.

[LocusCoeruleus]

OP, thanks for working through the math. Since the student is filing 8615, they’d need to do their own 1040 to be able to claim aotc but they are taxed at the parents marginal capital gains rate (15% or 20%) but not parents NIIT additional rate if parents have hit the threshold because the student wouldn’t hit the threshold in your examples above?

If true, seems like a loophole for parents to avoid niit by gifting to kids then selling; also the bogleheads wiki on kiddie tax should be updated or perhaps clarified because it does include niit.

[986racer]

OP, thanks for working through the math. Since the student is filing 8615, they’d need to do their own 1040 to be able to claim aotc but they are taxed at the parents marginal capital gains rate (15% or 20%) but not parents NIIT additional rate if parents have hit the threshold because the student wouldn’t hit the threshold in your examples above?

If true, seems like a loophole for parents to avoid niit by gifting to kids then selling; also the bogleheads wiki on kiddie tax should be updated or perhaps clarified because it does include niit.

Agreed. Many years ago when I first started this, I too thought that the child would pay NIIT as well. When I asked questions on the forum, somebody corrected that line of thinking. I then plugged sample numbers into TurboTax and found out that it was true that the child doesn’t pay NIIT based on the parents’ rate.

[rustlers]

OP, thanks for working through the math. Since the student is filing 8615, they’d need to do their own 1040 to be able to claim aotc but they are taxed at the parents marginal capital gains rate (15% or 20%) but not parents NIIT additional rate if parents have hit the threshold because the student wouldn’t hit the threshold in your examples above?

If true, seems like a loophole for parents to avoid niit by gifting to kids then selling; also the bogleheads wiki on kiddie tax should be updated or perhaps clarified because it does include niit.

Agreed. Many years ago when I first started this, I too thought that the child would pay NIIT as well. When I asked questions on the forum, somebody corrected that line of thinking. I then plugged sample numbers into TurboTax and found out that it was true that the child doesn’t pay NIIT based on the parents’ rate.

OP, I am in the process of planning this in TurboTax

1. Because of how the 8615 calculates the tax due to each child, it does this by adding the unearned income of all kids over deduction to the parents taxable income.

Then it calculates the difference in taxes, with that children income added and without. So, looks to me if the parent is subject to NIIT, the children will also be hit with the NIIT.

2. Secondary, if the parent was just under the 20% cap gains boundary without the children income, then by adding the children income will push the calculated impacted on children at 20% LTCG bracket, not 15%.

[986racer]

OP, I am in the process of planning this in TurboTax

1. Because of how the 8615 calculates the tax due to each child, it does this by adding the unearned income of all kids over deduction to the parents taxable income.

Then it calculates the difference in taxes, with that children income added and without. So, looks to me if the parent is subject to NIIT, the children will also be hit with the NIIT.

2. Secondary, if the parent was just under the 20% cap gains boundary without the children income, then by adding the children income will push the calculated impacted on children at 20% LTCG bracket, not 15%.

I just double checked on point 1... The children definitely are not hit with NIIT through this strategy as the calculations are all done pre-NIIT. You can see this as it finds the additional tax owed by calculating the new tax using standard tax tables (pre-NIIT) and then subtracting what the parent paid by looking at line 16 on the 1040. NIIT is added later on line 23.

Agreed with point 2. If you are on the bubble of 15% to 20%, the exact numbers will be a bit more difficult to calculate. My advice would be to try to overshoot just a bit so you don't leave a tax credit on the table.

[rustlers]

OP, I am in the process of planning this in TurboTax

1. Because of how the 8615 calculates the tax due to each child, it does this by adding the unearned income of all kids over deduction to the parents taxable income.

Then it calculates the difference in taxes, with that children income added and without. So, looks to me if the parent is subject to NIIT, the children will also be hit with the NIIT.

2. Secondary, if the parent was just under the 20% cap gains boundary without the children income, then by adding the children income will push the calculated impacted on children at 20% LTCG bracket, not 15%.

I just double checked on point 1... The children definitely are not hit with NIIT through this strategy as the calculations are all done pre-NIIT. You can see this as it finds the additional tax owed by calculating the new tax using standard tax tables (pre-NIIT) and then subtracting what the parent paid by looking at line 16 on the 1040. NIIT is added later on line 23.

Agreed with point 2. If you are on the bubble of 15% to 20%, the exact numbers will be a bit more difficult to calculate. My advice would be to try to overshoot just a bit so you don't leave a tax credit on the table.

Thanks for the update

[sketchy9]

OP, I am in the process of planning this in TurboTax

1. Because of how the 8615 calculates the tax due to each child, it does this by adding the unearned income of all kids over deduction to the parents taxable income.

Then it calculates the difference in taxes, with that children income added and without. So, looks to me if the parent is subject to NIIT, the children will also be hit with the NIIT.

2. Secondary, if the parent was just under the 20% cap gains boundary without the children income, then by adding the children income will push the calculated impacted on children at 20% LTCG bracket, not 15%.

I just double checked on point 1... The children definitely are not hit with NIIT through this strategy as the calculations are all done pre-NIIT. You can see this as it finds the additional tax owed by calculating the new tax using standard tax tables (pre-NIIT) and then subtracting what the parent paid by looking at line 16 on the 1040. NIIT is added later on line 23.

Agreed with point 2. If you are on the bubble of 15% to 20%, the exact numbers will be a bit more difficult to calculate. My advice would be to try to overshoot just a bit so you don't leave a tax credit on the table.

I'm interested in this discussion but isn't the kiddie tax using ordinary income tax rates, not capital gains rates?

[986racer]

OP, I am in the process of planning this in TurboTax

1. Because of how the 8615 calculates the tax due to each child, it does this by adding the unearned income of all kids over deduction to the parents taxable income.

Then it calculates the difference in taxes, with that children income added and without. So, looks to me if the parent is subject to NIIT, the children will also be hit with the NIIT.

2. Secondary, if the parent was just under the 20% cap gains boundary without the children income, then by adding the children income will push the calculated impacted on children at 20% LTCG bracket, not 15%.

I just double checked on point 1... The children definitely are not hit with NIIT through this strategy as the calculations are all done pre-NIIT. You can see this as it finds the additional tax owed by calculating the new tax using standard tax tables (pre-NIIT) and then subtracting what the parent paid by looking at line 16 on the 1040. NIIT is added later on line 23.

Agreed with point 2. If you are on the bubble of 15% to 20%, the exact numbers will be a bit more difficult to calculate. My advice would be to try to overshoot just a bit so you don't leave a tax credit on the table.

I'm interested in this discussion but isn't the kiddie tax using ordinary income tax rates, not capital gains rates?

It's ordinary income rates for STCG and capital gains rates for LTCG

For determining whether it is STCG or LTCG, if you gift the appreciated stocks, the clock starts ticking from your original purchase date, not the gifting date

[just_learning]

Interesting stuff.
Does this work for students that have some earned income? If a student has say 10k in wages do the numbers still hold?

Thanks.

[986racer]

Interesting stuff.
Does this work for students that have some earned income? If a student has say 10k in wages do the numbers still hold?

Thanks.

Yes. My kids had earned income. The numbers don’t change if their earned income is under the standard deduction amount. If they are over that then my advice is to run it through Turbo Tax (or the equivalent)

What I did for my kids who made more than the standard deduction is to calculate their tax bill both ways, I.e. with the capital gains and without and the make them “whole” afterwards

[just_learning]

Interesting stuff.
Does this work for students that have some earned income? If a student has say 10k in wages do the numbers still hold?

Thanks.

Yes. My kids had earned income. The numbers don’t change if their earned income is under the standard deduction amount. If they are over that then my advice is to run it through Turbo Tax (or the equivalent)

What I did for my kids who made more than the standard deduction is to calculate their tax bill both ways, I.e. with the capital gains and without and the make them “whole” afterwards

Thanks.
Just to make sure II am understanding this right, I am going to run the numbers-
Per this formula-
std deduction= min(13850, max(1250, earned income + 400)) and assuming earned income is 10500, the std deduction for the student will be 10900.
That means student is under std deduction amount of 13850 (for 2023).
So, the student would need to have 16667 of LTCG at a 15% parent tax rate to utilize all the 2500 credit.

One other question-
1. Does the wash sale rule apply here?
Lets say the parent wasn't considering selling their appreciated stock and they are sitting on 16667 of LTCG. And they happen to have a child in college. Could they then proceed with the back door and time the sale of gifted stock with a (re)purchase by themselves?
If yes, I assume the basis of the (re)purchased stock would be reset.

Thanks.

[986racer]

Interesting stuff.
Does this work for students that have some earned income? If a student has say 10k in wages do the numbers still hold?

Thanks.

Yes. My kids had earned income. The numbers don’t change if their earned income is under the standard deduction amount. If they are over that then my advice is to run it through Turbo Tax (or the equivalent)

What I did for my kids who made more than the standard deduction is to calculate their tax bill both ways, I.e. with the capital gains and without and the make them “whole” afterwards

Thanks.
Just to make sure II am understanding this right, I am going to run the numbers-
Per this formula-
std deduction= min(13850, max(1250, earned income + 400)) and assuming earned income is 10500, the std deduction for the student will be 10900.
That means student is under std deduction amount of 13850 (for 2023).
So, the student would need to have 16667 of LTCG at a 15% parent tax rate to utilize all the 2500 credit.

One other question-
1. Does the wash sale rule apply here?
Lets say the parent wasn't considering selling their appreciated stock and they are sitting on 16667 of LTCG. And they happen to have a child in college. Could they then proceed with the back door and time the sale of gifted stock with a (re)purchase by themselves?
If yes, I assume the basis of the (re)purchased stock would be reset.

Thanks.

I think the math in your instance would be 2500/.15 + 400, which totals to 17067. However, a really good thing to do here is to put the sample numbers in last year's Turbo Tax to confirm. If you use FreeTaxUSA, it does NOT handle this scenario appropriately and so you will need to switch to a different tax package.

The wash sale rule applies only when selling losses. Since you are selling gains it won't apply. So, yes, your repurchased stock effectively resets your basis

[just_learning]

Thank you for your response...

Wash sale- duh! I knew that...

[Citifan]

Are we sure this still works? Is it still enough to simply not claim the child as a dependent (even if you could)?

As someone suggested, I tried doing a dry run on turbotax. I put in my sons info. He will have about 6k in earned income.

Towards the beginning of the questions it asks if he can be claimed as a dependent on anyone else's return. I answer yes. That opened up another question if he WILL be claimed as a dependent. I answered no.

Turbotax is telling me he would be ineligible for the AOTC because someone else COULD claim him as a dependent.

I found the following on an irs faq page https://www.irs.gov/credits-deductions/ ... nd-answers

Q10. I'm just beginning college this year. Can I claim the AOTC for all four years I pay tuition?
A10. Yes, if you remain an eligible student and no one can claim you as a dependent on their tax return, the AOTC is available for qualifying expenses paid during each tax year.

[986racer]

Are we sure this still works? Is it still enough to simply not claim the child as a dependent (even if you could)?

As someone suggested, I tried doing a dry run on turbotax. I put in my sons info. He will have about 6k in earned income.

Towards the beginning of the questions it asks if he can be claimed as a dependent on anyone else's return. I answer yes. That opened up another question if he WILL be claimed as a dependent. I answered no.

Turbotax is telling me he would be ineligible for the AOTC because someone else COULD claim him as a dependent.

I found the following on an irs faq page https://www.irs.gov/credits-deductions/ ... nd-answers

Q10. I'm just beginning college this year. Can I claim the AOTC for all four years I pay tuition?
A10. Yes, if you remain an eligible student and no one can claim you as a dependent on their tax return, the AOTC is available for qualifying expenses paid during each tax year.

Positive it still works. I used it for 2 of my children last year. The IRS is very clear that it's a matter of whether the person is claimed as a dependent: https://www.irs.gov/publications/p970#e ... 1000204381

What is not available to someone who could be claimed as a dependent are the refundable credits. I.e., your child NEEDS to have tax liability to take advantage of Back Door AOTC. If you are only showing 6k of earned income, then you son will not have tax liability because his income is under the standard deduction.

[Citifan]

I thought the 1k would be available. And the additional 1500 would be if I gift him the stock to sell.

I'm planning to gift him 17k of stock (with 16500 of gains)

I put in those additional amounts into turbotax. But it is showing me that he's not eligible and the reason it states is because someone else can claim him as a dependent.

[986racer]

I thought the 1k would be available. And the additional 1500 would be if I gift him the stock to sell.

I'm planning to gift him 17k of stock (with 16500 of gains)

I put in those additional amounts into turbotax. But it is showing me that he's not eligible and the reason it states is because someone else can claim him as a dependent.

All of the 2500 requires tax liability. I.e., he's not getting the 1k unless he has tax liability.

To get Turbo Tax to show the credit, do the following
1. (You already did this step), check the box that shows that the student won't be claimed as a dependent
2. List your income in the "Federal Taxes" tab in the section labelled "Child's Income (Under Age 24)". This is what will trigger the kiddie tax on unearned income
3. List the investment income in "Federal Taxes" -> "Stocks, CryptoCurrency, Mutual Funds, Bonds, Other"
4. Finally, put in the 1098-T information in "Deductions & Credits" -> "Expenses and Scholarships (Form 1098-T)". After you put that in, it should ask you to run something called the "optimizer".

If you do all 4 steps above (make sure step 4 is last), you should then see the credit. If you already did step 4 and skipped one of the steps, just redo step 4 after you finish the one you missed.

[Citifan]

All of the 2500 requires tax liability. I.e., he's not getting the 1k unless he has tax liability.

To get Turbo Tax to show the credit, do the following
1. (You already did this step), check the box that shows that the student won't be claimed as a dependent
2. List your income in the "Federal Taxes" tab in the section labelled "Child's Income (Under Age 24)". This is what will trigger the kiddie tax on unearned income
3. List the investment income in "Federal Taxes" -> "Stocks, CryptoCurrency, Mutual Funds, Bonds, Other"
4. Finally, put in the 1098-T information in "Deductions & Credits" -> "Expenses and Scholarships (Form 1098-T)". After you put that in, it should ask you to run something called the "optimizer".

If you do all 4 steps above (make sure step 4 is last), you should then see the credit. If you already did step 4 and skipped one of the steps, just redo step 4 after you finish the one you missed.

Thanks so much! I was missing #2 either I overlooked it or it was not showing up when I was in that section. Strange errors from turbotax but I'm glad you explained it.

Now I just need to tinker with the numbers to get the most out of the credit. My son will have some income from dividends/interest too.

This is a great strategy and I plan use it in the fall.