Sometimes Short is Sweet: Choosing the Right Tax Form Can Affect College Financial Aid

Many tax professionals will never bother with the short 1040-A and 1040-EZ forms when filing their clients’ taxes.

Unless they understand a bit of obscure college tax planning.

When a family is eligible to file these little forms, big savings can happen. Call it a loophole, or call it a secret. But sometimes big things come in small packages.

The use of the 1040-A and 1040-EZ forms is an often-overlooked tax planning tool. They could actually cause the parent’s and student’s assets to be excluded from a behind-the- scenes “test” on the FAFSA form. That test is important because it plays into the determination of the amount financial aid a student will [or will not] receive.

Think of a little red button. Press the button, and something happens. On the FAFSA, if you can say that you filed the 1040A or 1040EZ, you could trigger a financial aid benefit you may not otherwise have qualified for. Pressing the button launches the “Simplified Needs Test” (SNT). If you pass the SNT, your assets could be excluded from a calculation known as the “Expected Family Contribution” (EFC). The EFC is the bottom line amount that the government feels the student and family can afford to contribute to college education.

Think of it this way-

The simpler your taxes, the less money you [supposedly] have. And the more money you [need] can qualify for on your FAFSA. Less is more.

A Closer Look

The pdf version of the 2016-2017 FAFSA can be found here: https://fafsa.ed.gov/fotw1617/pdf/PdfFafsa16-17.pdf

The SNT pops up twice on the FAFSA – once in a question for parents, and once for the student. See Questions 35 and 83 below – “if you filed or will file a 1040, are you eligible to file a 1040A or 1040 EZ?”

[image a] [image b]

Now that we understand that SNT affects the (EFC) calculation, let’s talk about how that calculation works.

EFC is simple to understand.  It’s based on NEED.

COST OF ATTENDANCE

Less(-): ESTIMATED FAMILY CONTRIBUTION

Equals(=): YOUR NEED

The HIGHER the need, the LOWER the EFC.

The less money you have, the more you need, because you have less to pay for education. The best possible EFC that you can have is ZERO, because you’re a candidate to receive the highest possible financial aid award possible. Even if the tuition is higher than what the government will contribute, schools that offer need – based scholarships could extend a valuable financial aid scholarship package to the student based on the [low] EFC. This depends on the school, of course, but we now understand why this EFC number is so important. Sometimes a child whose EFC is very low can actually go to a very expensive school. Many schools have foundations, grants and other awards set aside for students with financial need.

But how is the EFC calculated to begin with?  This is where the Simplified Needs Test (SNT) comes into play.

Remember we mentioned earlier that SNT decides whether assets are included or excluded from the EFC formula. Here is how it works:

The income limit eligibility criteria for filing the simple 1040A, is income up to $50,000. ‘Income’ is the key word here. I-N- C-O- M-E.

Many schools have their own financial aid forms. These forms ask about assets. But for this SNT calculation, the pertinent information is ONLY INCOME.

Would that not mean that theoretically, Mom and Dad could both be unemployed, receive $49,999 in interest income and have $1 million in assets — – with no other income from work –
yet still qualify for Federal financial aid, since the assets will be excluded?

Read that again.

This actually happens. A perfect example might be a divorced single mother living in the home she purchased while married to the father of her child.  Now she files her tax return as single, and
has a much lower income.  Most accountants would want to file a 1040 and itemize.  But that might not be the best way for her to go depending on the child’s college plans.

I’ve seen this happen with one of my own clients. She was struggling to pay her bills, she filed a 1040A, got a Zero EFC, and her son went to Harvard.

Recently I used an online EFC calclulator that predicts EFC based upon the financial information entered.  The parent’s income was within the limits we are discussing ($49,999 or less).   The EFC was $20,000. Without touching any other field, I changed '1040' to '1040A' as the parent’s tax form.   The EFC fell from $20,000 to ZERO in the blink of an eye.

Here is an example of an EFC calculator that you can try:
https://bigfuture.collegeboard.org/pay-for- college/paying-your- share/expected-family-contribution-calculator#efc_status

More information about the EFC formula, including sample worksheets and in-depth information can be found here:

https://ifap.ed.gov/efcformulaguide/attachments/100615EFCFormulaGuide1617Attach.pdf

Before moving further, there is one point worth mentioning about assets. The discussion above pertains to parent’s assets, not the student’s. This is important since the FAFSA does put weight on student assets:

PARENTS’ CONTRIBUTION +

STUDENT’S CONTRIBUTION FROM INCOME +

STUDENT’S CONTRIBUTION FROM ASSETS =

EXPECTED FAMILY CONTRIBUTION

This is another area that might require tax and financial planning, but it is a discussion for another time.

Does this mean that parents who qualify to file a 1040A or 1040EZ should not file a 1040?

No! Every family is different, and so are their finances. It’s important to evaluate whether itemizing is best, or if there are any credits or deductions that can be taken on the 1040, as they could outweigh the benefit of financial aid.  Another possible consideration would be if the child is going to a local public state university or college, and whether the college cares about the EFC.

“If the student is applying to a private school, the tuition is going to be much higher.  In this case, it would be worthwhile to investigate what kind of financial aid packages the schools tend to offer. Sometimes the wealthier the school, the better the scholarship!  It’s a lot of work, but getting that EFC down could save a family tens of thousands, and even hundreds of thousands of dollars sending their children to college.”

Should students file the 1040EZ?

That’s a good question. Remember, we want to trigger that red button on the FAFSA. However many young students are still dependents of their parents, and are not required to file a tax return.
The IRS has an online interview tool that determines whether you must file a tax return: https://www.irs.gov/help/ita/do-i- need-to- file-a- tax-return

But that is actually irrelevant.

Here’s the clencher: The FAFSA question states, ‘Were you eligible to file a 1040A or 1040EZ?'  Being eligible is good enough.  Even if a student didn’t file (because he or she did not have to), they can still push that button. Don’t say 'Don’t know,' say 'Yes.' Could “Don’t know” be a distraction to trick you into not pushing the button? Maybe.

What else might parents be concerned about in choosing the right tax form for college financial aid planning purposes?

The tax code is complex, and what helps one family may not do a thing for another. There are many factors that can come into play on a tax return.

For example, let’s take a family who received state refunds by itemizing on Schedule A in prior tax years. By filing a short form instead of a 1040, a recapture might be the result. However
there is no area on the short form to record this recapture. If the savings truly outweighs the recapture, then the only way around this problem would be to file an amended 1040X.

Additionally, IRS formulas are different than financial aid formulas, and choosing a tax professional who understands the differences can be paramount.  With the cost of college skyrocketing to outer space, many parents who previously thought they would not qualify for financial aid often have a good shot at sending their children to a great school if they get the right advice.  Parents who are very serious about helping their children get the best education possible would do well to consult with a reputable college financial aid counselor who has an in-depth knowledge of tax (or vice versa) in order to help plan ahead and devise the best strategy.

Kids are our future.  Let’s send them to school!

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Renee Schweke

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