The role of grandparents has changed over time, and many have an active and responsible role in the financial support of their grandchildren. Those who can track their financial support to grandchildren can help reduce tax liability by receiving all of the exemptions, deductions and credits available to grandparents in such situations.
American Opportunity Tax Credit
The American opportunity tax credit is a component of the American Recovery and Reinvestment Act. This tax credit allows for the deduction of a maximum allowance of $2,500 per college student during each calendar year. The caveat of this tax break, in regard to grandparents, is that the student must be considered and reported as a dependent for the grandparents to take the deduction. A dependent grandchild must live with the grandparents for more than half the year, and the grandparents must provide at least half the student's routine support.
College Tuition Payments
Grandparents who help financially support a child attending college can be subject to gift taxes if they give college tuition funds over a certain amount to the student. To bypass this tax burden, grandparents can pay college tuition directly to the school.
529 Savings Plans
Grandparents can help minor children build college savings by opening or contributing to a 529 savings plan. No federal tax deduction is recognized through participation in such a plan; however, no gift taxes are levied on the amount deposited and interest earned on the account isn't taxed. Grandparents who can afford to make the maximum level of contributions to this type of account can recognize reduced taxes by immediately enjoying five years' worth of annual gift tax exclusions.
One of the ways grandparents can truly realize large tax deductions is to have the grandchild live with them full time and pay for the child's routine care. Grandparents claiming minor children as dependents can benefit by being able to take the child and dependent care credit, increase the number of dependent exemptions on their tax return and perhaps claim the earned income credit if they work and have low-to-moderate wages.