Choosing the Right Tax Form: Tips for College Students and their Parents
Using Form 1040-A Can Qualify a Student for the Simple Needs Test
Parents and college students who are eligible to file the shorter Forms 1040-EZ or 1040-A at tax time might also qualify for the Simplified Needs Test that determines college financial aid. Filing these forms can exclude parents' and students' assets from the calculation of federal financial aid, so you might want to consider using one of these shorter and easier tax forms.
What Is the Simplified Needs Test?
Qualifying for the Simplified Needs Test (SNT) means that a college student might receive a larger financial aid package.
Taxpayers who would otherwise benefit from itemizing their deductions or filing the 1040 long form instead might realize a greater benefit from filing the short form if doing so would result in substantially increased financial aid.
"The SNT is question 34 on the FAFSA form," according to Rivkah Schweke, an enrolled agent who also works as a financial aid counselor. "The purpose of the question 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."
Students and parents must have less than $50,000 in adjusted gross income to qualify for the SNT in 2018. Your taxable income must be less than $100,000 to be eligible to file Form 1040-A, 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 their assets for the estimated family contribution.
What's the Benefit of Meeting the Simple Needs Test?
"The SNT affects the estimated family contribution (EFC) calculation," Rivkah Schweke continues.
"The EFC is easy 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, and a low EFC is good news. It translates into higher needs-based federal and state grants and subsidized Stafford student loans. Subsidized loans are good because the government pays the interest while the child is in school. If your EFC is zero, you're 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're willing to offer.
“Sometimes a family has a low EFC can send their child to a very expensive school because the school extends a valuable financial aid scholarship package to the student based on the low EFC."
The Simplified Needs Test and the EFC Calculation
But how is the EFC calculated to begin with? This is where the SNT comes into play.
“The SNT decides whether assets are included or excluded from the EFC calculation," according to Schweke. "Let's say that the parent's income is $50,000. Would that not mean that, theoretically, the parent could have $49,999 in interest income and $1 million in assets and no other income from work yet still qualify for federal financial aid because 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.
“Remember 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."
How Does Filing the 1040A or 1040EZ Help?
"I recently had a client who fit the income limits we're discussing," Schweke says. "Without changing a single item of income or assets, we simply changed Form 1040 to Form 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."
This correct in theory, but each family is different and so are their finances. It’s important to evaluate whether itemizing or filing the long form is best and if there are any credits or deductions that could be taken on the 1040 that 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," Schweke points out. "In this case, it might be worthwhile to investigate what kind of financial aid packages the school offers. 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 don't file a tax return," Schweke says, "especially when they're still their parents' dependents. The rule as of 2018 is that if a single taxpayer under age 65 does not earn at least $10,400, he's not required to file.
"The FAFSA questionnaire asks, 'Were you eligible to file a 1040A or 1040EZ?' Being eligible is good enough. You don't have to actually file. So don’t say that you don't know on question 34. Say yes."
“The tax code is complex, and many factors can come into play on a return," Schweke explains. "For example, if there were state tax refunds available in previous years for a taxpayer who itemized, filing a short form could trigger a recapture. But there's no way to record it on a short form so only a 1040X—an amended tax return—could solve the problem.
“Additionally, IRS formulas are different from financial aid formulas so choosing a tax professional who understands the differences can be paramount. With the cost of college education skyrocketing into 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 laws and implications as well 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.