Choosing the Right Tax Form: Tips for College Students and their Parents

Using Form 1040-A may qualify the student for the simplified needs test

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Parents and college students who are eligible to file the shorter Form 1040-EZ or Form 1040-A might also qualify for the Simplified Needs Test for college financial aid purposes, resulting in the parents' and student's assets being excluded from the calculation of federal financial aid. This is why parents of college-bound students may want to take a closer look at the “shorter” or “easier to file” tax forms 1040-A and 1040-EZ when reporting and filing their taxes.

Qualifying for the Simplified Needs Test means that a college student may get a larger financial aid package. Therefore, taxpayers who might otherwise benefit from itemizing their deductions (and thereby needing to file the 1040 long form) might benefit from filing the short form instead (without itemizing) if doing so would result in substantially increased financial aid. I interviewed Rivkah Schweke, an enrolled agent who also works as a financial aid counselor regarding this topic. She had a lot of very helpful information on the topic below.

What's the Simplified Needs Test?

"The Simplified Needs Test," Rivkah Schweke explains, "is question 34 on the FAFSA form.  The purpose of it is to determine whether assets will be counted or excluded in the Expected Family Contribution (EFC) Calculation.  The EFC represents the amount of money the government feels the student and family can afford to contribute toward his or her college education.

  Simply stated, the lower the number, the less you’re expected to pay.  The best score possible is ZERO."

To qualify for the Simplified Needs Test, students and parents would need to have less than $50,000 of adjusted gross income, while to be eligible to file Form 1040-A, a person's taxable income must be less than $100,000 (among other criteria).

Parents who have adjusted gross income of less than $50,000 will want to consider using Form 1040-A instead of the longer Form 1040, in order to exclude the parents' assets for the estimated family contribution.

What's the benefit of meeting the simple needs test?

"The Simplified Needs Test (SNT) affects the estimated family contribution (EFC) calculation," Rivkah Schweke continues. "Before we discuss the SNT, let’s talk more about the EFC."

"EFC is simple to understand.  Let's begin with defining 'need':

COST OF ATTENDANCE

Less(-): ESTIMATED FAMILY CONTRIBUTION

Equals(=): YOUR NEED

"The HIGHER the need, the LOWER the EFC."

"A low EFC is good news. It translates into a higher need-based Federal and State grants, and subsidized Stafford student loans.  Subsidized is good because it means that the government pays the interest while the child is in school.  If your EFC is zero, you are in a position to receive the absolute maximum allowable financial aid.  Additionally, schools use this number as a guide to determine how much of a financial aid package they are willing to offer."

“Sometimes a child whose family has a low EFC can send their child to a very expensive school, because the school could extend a valuable financial aid scholarship package to the student based on the [low] EFC.”

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

“SNT decides whether assets are included or excluded from the EFC calculation. Why is this so important?”

“Eligibility guideline for the 1040A, the threshold for income is $50,000. Would that not mean that theoretically, you can have $49,999 in interest income and $1 million in assets and no other income from work – yet still qualify for Federal financial aid, since the assets will be excluded?  This happens more often than you might think.  A perfect example might be a divorced mother living in the home she purchased while married to her children’s father.  Now she files 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 in this situation.”

“Moving further, remember we said that 'cost of college' less 'family contribution' equals 'student need'? Let’s take it a bit further and put it this way:

PARENTS’ CONTRIBUTION +

STUDENT’S CONTRIBUTION FROM INCOME +

STUDENT’S CONTRIBUTION FROM ASSETS =

EXPECTED FAMILY CONTRIBUTION

"Now it becomes clear why it’s better to exclude the child’s assets.”

"In order to help people with tax and asset planning for college finance purposes, I use an EFC estimator tool that predicts EFC based upon the financial information entered into the fields on the form.  Here is a perfect example of what I’m talking about:  Recently I had a client who fit the income limits we are discussing.  Without changing a single item of income / assets etc., we simply changed '1040' to '1040A' as the parent’s tax form.   The EFC dropped from $20,000 to ZERO in the blink of an eye.  $20,000 a year times four years is a whopping savings of $80,000 for one child."

So, basically, if parents of college students qualify for the 1040A or 1040EZ, they should use that form instead of a 1040?

“As a general rule, this is correct in theory.  However, each 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.”

“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.”

Does the same go for the students too?

“Many young students do not file a tax return, especially when they are still dependents of their parents.  The rule (in 2012) is that if a taxpayer does not earn at least $9,750, they are not required to file.  The FAFSA question states, 'Were you eligible to file a 1040A or 1040EZ?'  Being eligible is good enough.  On question #34, don’t say 'Don’t know,' say 'Yes.'"

Are there any other things we should be concerned about in choosing the right tax form for college students and their parents?

“The tax code is complex, and many factors can come into play on a return.  Here’s an example:  If there were state tax refunds available in previous years due to itemizing, a short form could trigger a recapture. However, there is no way to record it on a short form, and therefore, only a 1040X – an amended form - could solve the problem.” 

“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!” 

Rivkah Schweke is an Enrolled Agent with a strong interest in college financial aid planning.  She understands both the federal tax code and the financial aid methodology.  She can be reached at Bridge Financial Solutions.