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If the student is a dependent student, the student’s parents will need to provide basic information about their finances on the Free Application for Federal Student Aid (FAFSA), including information about the parents’ adjusted gross income (AGI), untaxed income and the current net worth of certain assets.
The Family Educational Rights and Privacy Act of 1974 (FERPA), a federal privacy law, precludes colleges and universities from disclosing parent financial information to the student. This includes parent financial information on financial aid application forms. Parents who have privacy concerns, such as divorced parents, should discuss these concerns with the college’s financial aid office.
Parents may use the IRS Data Retrieval Tool (IRS DRT) to pre-fill tax and income information in the parent section of the FAFSA. The IRS Data Retrieval Tool becomes available in early February or approximately 3 weeks after the parents file federal income tax returns electronically. Since many parents will need to file the FAFSA with estimated income information before filing their federal income tax returns, parents can also use the IRS Data Retrieval Tool to update the tax and financial information on the FAFSA after filing their federal income tax returns.
This FAFSA question asks the parents to provide information about their tax filing status. If the parents answer “Already completed,” the form may allow them to use the IRS Data Retrieval Tool to pre-fill the answers to some of the financial and tax questions. If the parents answer, “Will file,” and provide an email address, the U.S. Department of Education will email them a reminder after April 15 to update the financial and tax information on the FAFSA after their federal income tax returns have been filed by using the IRS Data Retrieval Tool.
If a parent selects, “Not going to file,” but his or her income is above the IRS tax-filing threshold, the FAFSA will be selected for verification. Failure to file required federal income tax returns may affect the student’s ability to receive need-based student aid. The income threshold for filing a federal income tax return is generally the sum of the standard deduction and the minimum number of exemptions that can be claimed by the taxpayer (e.g., one exemption for single filers and two exemptions for married filing jointly). The current income thresholds appear in Table 1-1 in Chapter 1 of IRS Publication 17. Such a discrepancy represents conflicting information that must be resolved before the college financial aid administrator may disburse federal student aid funds.
(There is an exception to the timely filing requirements for active duty members of the U.S. Armed Forces serving in a combat zone. Also, taxpayers who file IRS Form 4868 to get an automatic 6-month extension must provide the college with a copy of their W-2 forms and must either use the IRS Data Retrieval Tool or provide a tax transcript after their federal income tax returns are filed.)
The question about the parents’ income tax return filing status is used to identify discrepancies between the filing status on the federal income tax return and marital status on the FAFSA. It may also be used to help select FAFSAs for verification. For example, the head of household tax-filing status is error prone, since it offers a greater standard deduction than other tax filing statuses. Even if the U.S. Department of Education does not select the FAFSA for verification, many college financial aid administrators will select the FAFSA for verification because of the likelihood of error involving the reported head-of-household status. Most taxpayers who claim head of household status do so incorrectly.
Tax filing status does not otherwise affect eligibility for federal student aid funds obtained through the FAFSA. It may, however, affect eligibility for certain education tax benefits. In particular, the American Opportunity Tax Credit, Lifetime Learning Tax Credit, tuition and fees deduction and student loan interest deduction are not available to taxpayers who file as “Married, filing separately” on their federal tax returns.
The next question asks about parents’ 2014 adjusted gross income (AGI). The AGI is the total of all income that will be listed on the 2014 federal income tax return before it is reduced by deductions, exemptions and tax credits. It includes earned income, such as wages, salaries, bonuses and tips, as well unearned income, such as interest and dividend income, capital gains, alimony received, business and rental property income, unemployment benefits and the taxable portion of pensions, IRA distributions and Social Security benefit payments. The AGI is reduced by alimony paid, the penalty on early withdrawal of savings and certain other above-the-line exclusions from income, such as the student loan interest deduction, tuition and fees deduction, educator expenses and moving expenses.
If the parents have not yet completed their 2014 federal income tax returns, FAFSA on the Web (FOTW) provides an “Income Estimator” that can help them calculate an estimate of their 2014 AGI. If the parents have not yet filed their 2014 federal income tax returns, it is ok to use estimated 2014 income information on the FAFSA. Estimates can be based on W-2 and 1099 statements, the last pay stub of the year from each employer, and the previous year’s federal income tax returns. The parents will be required to update the FAFSA later using the IRS Data Retrieval Tool, after they file their actual 2014 federal income tax returns.
These questions ask about custodial parent earnings from sources such as wages, salaries and tips. These questions must be answered whether or not the parents file a tax return. This information may appear on the parents’ W-2 and 1099 forms, or on IRS Forms 1040, 1040A or 1040EZ.
The FAFSA instructions base income earned from work on
Combat pay should not be included in income earned from work.
Income earned from work is used to calculate an allowance for FICA taxes (Social Security and Medicare tax), an allowance for state and other taxes and the employment expense allowance. These and other allowances are subtracted from income when calculating the expected family contribution (EFC).
Income earned from work is also used instead of adjusted gross income (AGI) for people who are not required to file a federal income tax return.
Unfortunately, the FAFSA instructions do not correctly include all income earned from work. This usually leads to a higher expected family contribution (EFC), hurting the applicant’s eligibility for need-based student aid. The current instructions omit partnership income (which is usually reported on line 17 of IRS Form 1040), exclude retirement plan contributions (line 7 of IRS Form 1040 is based on Box 1 of the W-2 statements instead of Box 5), include taxable scholarships and fellowships (which are usually not subject to FICA taxes) and include the employer FICA contribution. The instructions also do not correctly address situations when the parents have two sole proprietorships, one with negative income that offsets positive income from the other. Nevertheless, applicants must follow the FAFSA instructions as written.
This question asks for the amount of the parents’ federal income tax for 2013. This question is based on the total income tax before the addition of other taxes, such as self-employment tax and household employment taxes.
The FAFSA instructions specify that the taxpayer should report line 55 of IRS Form 1040, line 35 of IRS Form 1040A or line 10 of IRS Form 1040EZ. This is the last line of the Tax and Credits section of the federal income tax return. It reports the total federal income tax, not the total taxes. It does not include any of the taxes listed in the Other Taxes section of the federal income tax return.
Self-employed individuals often wonder why the FAFSA doesn’t include the self-employment tax reported on line 58 of IRS Form 1040 as part of taxes paid. The FAFSA calculates the employee’s share of FICA taxes based on income earned from work. This calculation occurs behind the scenes. The employer’s share of FICA taxes is excluded from the employee’s wages except for self-employed individuals, where the employer’s share of FICA taxes is subtracted from adjusted gross income (AGI) by line 27 of IRS Form 1040. So, if an applicant were to include self-employment tax from line 58 of IRS Form 1040 as part of the taxes paid figure, the applicant would be double-counting the self-employment taxes.
Report the federal income tax figure based on the specific lines of the federal income tax return. Do not use a different line of the federal income tax return or add other tax liabilities to this figure.
Other common errors include:
Report the total number of exemptions claimed on the parents’ federal income tax return, regardless of whether or not they are counted in household size. Household size on the FAFSA and the number of exemptions on the federal income tax return are based on different definitions and are not necessarily equal. For example, exemptions are based on the prior tax year while household size is based on the award year. The IRS and FAFSA also use different definitions of support.
The number of exemptions appears on line 6d of IRS Forms 1040 and 1040A.
IRS Form 1040EZ reports a combination of the exemption amount and standard deduction on line 5 instead of a number of exemptions. If the taxpayer does not check either of the boxes on line 5, report one exemption if the taxpayer is single or never married and two exemptions if the taxpayer is married. If either box is checked, divide line F of the 1040EZ Worksheet for line 5 by $3,900, the exemption amount per exemption.
Although the number of exemptions may differ from household size, college financial aid administrators may question a significant discrepancy between the two numbers. If this occurs, be prepared to explain this apparent discrepancy.
Certain types of income and expenses are excluded from income by the federal financial aid formula. For example, the taxable portion of need-based student aid is excluded from income for federal student aid purposes. These exclusions are reported in the Additional Financial Information section of the FAFSA so that they can be subtracted from adjusted gross income when calculating the student’s eligibility for need-based financial aid.
The exclusions from income include the following figures from the parents’ income tax return:
Families sometimes incorrectly report the full amount of a scholarship on the FAFSA. This question is intended to compensate for the portion of a scholarship or similar aid that was included in adjusted gross income. The taxable portion of scholarships, grants and similar aid is typically written next to the line where wages are reported on the federal income tax return, along with the letters “SCH.” The taxable portion of scholarships and similar aid reported on the FAFSA must match this figure. Do not report the tax-free portion of a scholarship or similar aid on the FAFSA.
Combat pay for enlisted persons and warrant officers is entirely tax-free. Only commissioned officers may have some taxable combat pay, generally equal to the amount that exceeds the highest pay for an enlisted person. Total combat pay is listed on the servicemember’s leave and earnings statement. The untaxed portion is reported with a Q code in Box 12 of the W-2 statement. The difference is the taxable portion of combat pay. Do not use the amount from Box 1 of the W-2 statement.
Some families may get confused by the child support questions. There are two questions, one for child support paid and one for child support received. Do not incorrectly report child support received in the child support paid question or vice versa. Report only child support paid or received because of a legal requirement, such as a child support agreement, divorce decree or legal separation. Child support received outside of a legal agreement should be reported as untaxed income.
Certain types of untaxed income are counted by the federal need-analysis formula despite not being included in adjusted gross income.
These types of untaxed income include:
The latter catch-all category does not include several types of untaxed income and benefits, including:
The intention of this section is to include untaxed income of a discretionary nature in total income. Non-elective pension plan and retirement plan contributions are not counted in untaxed income. For example, contributions to certain state public employee retirement systems, such as the IPERS (Iowa), KPERS (Kansas) and OPERS (Ohio) retirement systems, are involuntary and so should not be reported as untaxed income on the FAFSA. Contributions to a 401(k), 403(b) or IRA, on the other hand, are voluntary and must be reported as untaxed income on the FAFSA. Likewise, contributions by federal employees to the Thrift Savings Plan (TSP) are voluntary and, therefore, represent untaxed income. Note that employer contributions to retirement plans, health benefits and pension plans are not counted in untaxed income.
Note that the parents’ untaxed income section does not include a question for “money received, or paid on your behalf” while the student’s untaxed income section does. This question concerns cash support, such as money, gifts and loans, plus expenses paid by others on the student’s behalf. Support includes not just cash, loans and gifts, but also any expense the student would otherwise have had to pay, such as housing, medical/dental insurance, car payments and insurance, college costs, food, clothing, etc. If the student lives with his or her parents, there will be a presumption that the parents are providing more than half support if the parents are paying for the housing costs. So, while a student would have to report a gift from his or her grandparents as untaxed income on the FAFSA, the student’s parents do not have to report gifts they receive.
The net worth of certain parent assets is reported on the FAFSA. The net worth of an asset is the current market value of the asset minus any debts secured by the asset. If the net worth of an asset is negative, it is reported as having zero value on the FAFSA.
The asset value is reported as of the date the FAFSA is filed. In practice, this should be the asset value from the most recent bank or brokerage account statement received prior to the date the FAFSA was filed. If the FAFSA is selected for verification, the college financial aid administrator may ask for a copy of the bank or brokerage account statement to document the asset’s value as of the date the FAFSA was filed.
If the family is buying or selling some assets before the FAFSA is filed, it is best to do this soon enough that it will appear on a bank or brokerage account statement received before the date the FAFSA is filed. Otherwise, the family should print a copy of the online bank and brokerage account statements as of the date the FAFSA is submitted and keep that copy in case it is requested by the financial aid administrator.
Reportable assets include cash, bank and brokerage accounts, certificates of deposit (CDs), stocks, bonds, mutual funds, money market accounts, stock options, restricted stock units, ETFs, hedge funds, REITs, commodities and precious metals, businesses, investment farms, investment real estate, private equity, trust funds, college savings plans and other investments.
Reportable assets do not include the family’s principal place of residence (the family home), a family farm (if it is the family’s principal place of residence and the student and/or parents materially participate in the farming operation), any small business owned and controlled by the family, qualified retirement plans, life insurance plans and personal possessions (e.g., clothing, furniture, personal automobiles, computer equipment and software, and television and stereo equipment).
Note, small businesses have less than 100 full-time or full-time equivalent employees. To be controlled by the family, the family must own more than 50 percent of the business.
If an asset is owned by more than one person, the parent(s) should report only their share of the asset. Unless a legal agreement specifies a different division, ownership of the asset should be divided equally.
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