College-Bound Kids and Taxes

Quick Summary: College costs can affect a family’s taxes in more ways than expected. For Iowa Falls families, decisions about claiming a student as a dependent, using education tax credits, taking 529 plan distributions, and handling scholarships can all work together. Eric J. Brunsen CPA helps families review these moving pieces so they can better understand the tax benefits that may be available for 2026.

Can Parents Claim a College Student as a Dependent?

Many parents can continue claiming a child as a dependent while that child is attending college. A full-time student may qualify through age 23, and living on campus or away from home for school is generally considered a temporary absence for IRS residency purposes. In other words, attending college away from home does not automatically prevent a parent from claiming the student.

Financial support is an important part of the analysis. In most cases, the student cannot have provided more than half of their own support for the year. This calculation can be less straightforward than it sounds when a student has wages, savings, grants, or scholarships.

Scholarships usually are not treated as support supplied by the student when determining dependency. That distinction may allow parents to meet the support test even when scholarship funds cover a substantial share of college costs. Since dependency affects access to education-related tax benefits, it is worth reviewing the facts before deciding whether the student should file as independent.

Compare the Available Education Tax Credits

Two major education credits may be available to qualifying taxpayers: the American Opportunity Tax Credit and the Lifetime Learning Credit. They apply in different situations, so selecting the appropriate credit can have a meaningful effect on a family’s tax return. Only one of these credits can be claimed for the same student in the same tax year.

The American Opportunity Tax Credit, often called the AOTC, can be especially useful for undergraduate students. It may provide as much as $2,500 for each eligible student during the first four years of postsecondary education. In addition to tuition and required fees, qualifying expenses can include certain course materials purchased outside the college or university.

The Lifetime Learning Credit, or LLC, can be worth up to $2,000 per return. Its reach is broader because it may apply to graduate-level coursework and classes intended to improve or develop job skills. Unlike the AOTC, the LLC does not have a limit on the number of years it can be claimed.

Neither credit covers room and board, even though those expenses often account for a significant portion of a student’s total college budget. Families should also keep in mind that the taxpayer who claims the student as a dependent is generally the person who evaluates and claims the related education credit.

Education Credit Requirements to Review for 2026

For 2026, identification requirements remain an essential detail when claiming an education credit. The taxpayer claiming the credit must have a valid Social Security number issued before the due date of the return. In many situations, the student must meet that same requirement.

It may seem like a basic administrative issue, but an incorrect or outdated identification number can affect eligibility and delay processing. Confirming this information well before filing season can help prevent an avoidable problem.

Families should also avoid relying only on Form 1098-T to calculate an education credit. The form reports tuition-related information, but it may not show the precise amount of expenses that qualify for a credit. Scholarships, refunds, required materials, and other adjustments can change the final calculation, making a full review of records important.

Plan 529 Withdrawals Alongside Tax Credits

A 529 plan can be a valuable way to save and pay for education. Withdrawals are generally tax-free when used for qualified expenses, including tuition, books, supplies, and room and board for a student enrolled at least half-time. The ability to use 529 funds for housing costs is an important benefit for many families.

Still, the qualified-expense rules for 529 distributions are not identical to the rules for education credits. Room and board, for example, can qualify for a tax-free 529 withdrawal but cannot be used to support an AOTC or LLC claim. Understanding that difference can help families decide which expenses to assign to each benefit.

Generally, the same expense cannot support both a tax-free 529 plan distribution and an education tax credit. Using the funds without coordinating them may cause a family to lose a credit or create taxable 529 distributions. A thoughtful plan can help preserve the value of both options.

Unused 529 plan money may also have future flexibility. Under current guidance, certain unused funds can potentially be moved into a Roth IRA for the beneficiary, subject to limitations that include a lifetime cap and account-age rules. This can offer a longer-term use for education savings that are not needed for college costs.

How Scholarships Can Change the Tax Outcome

Scholarships can lower the amount a family pays out of pocket, but their tax treatment depends on how the money is used. Scholarship amounts applied to tuition, required fees, and required course materials are generally tax-free. Amounts used for other costs, including room and board, may be taxable income to the student.

In some cases, the allocation of scholarship funds can influence whether a family qualifies for a larger education credit. For example, treating a portion of scholarship income as taxable to the student may leave more qualified expenses available for an education credit. This is not a one-size-fits-all strategy, but it shows why scholarship decisions should be considered alongside the rest of the family’s tax return.

A larger scholarship does not always produce the most favorable overall tax result automatically. Looking at where scholarship dollars are applied, and how that affects credits and other benefits, can make a meaningful difference.

Student Earnings and Student Loan Interest

College students often earn money through campus jobs, part-time employment, internships, freelance projects, or other gig work. Depending on the amount and type of income, a student may need to file a federal tax return even if their parents claim them as a dependent. Dependency and filing requirements are separate issues, so one does not necessarily eliminate the other.

Self-employment and gig income deserve particular attention because they can bring additional tax responsibilities. Even when a return is not required, filing may still be worthwhile if the student has had tax withheld and could receive a refund.

Families that pay qualifying student loan interest may be eligible for a deduction of up to $2,500, subject to applicable income limits. While this deduction does not eliminate education debt, it can help reduce the long-term tax cost associated with repayment.

Why College Tax Planning Works Best as a Whole

College tax decisions are connected. Whether a parent claims a student as a dependent can affect education credits, while scholarship treatment may affect both credits and taxable income. A 529 withdrawal may be tax-free, but only if it is coordinated properly with other qualified expenses.

Reviewing each item separately can lead to missed tax advantages or unintended tax consequences. Looking at dependency, scholarships, 529 distributions, student earnings, and education credits together gives families a clearer picture of their options.

Eric J. Brunsen CPA provides tax preparation and practical tax guidance for individuals and families in Iowa Falls, Alden, Ackley, Eldora, Hampton, and nearby communities. If your family is preparing for college expenses or reviewing your 2026 tax situation, our local CPA firm can help you organize the details and make informed decisions about available tax benefits.