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The FAFSA (and most other financial aid formulas) is heavily weighted toward income:
Income has a much greater impact on eligibility for need-based financial aid than assets (like the money you have in cash, checking, savings, or investments).
Income affects financial aid eligibility in two main ways:
Before we talk about how your income can hurt you in financial aid formulas, let’s talk about something that can help you: the income protection allowance. Basically, it’s an amount of income that doesn’t get counted when figuring out your financial aid. It’s your survival money, and it’s protected.
If you are a dependent student, the student income protection allowance is about $6,570 — meaning there is nothing counted toward your contribution if you have $6,570 or less in yearly taxable and untaxable income. The parent income protection allowance typically varies from about $18,300 to about $38,880, depending on how many people are in your family and how many of them are in college.
Income above those income protection allowances is considered your “discretionary” income — and that’s what counts toward your contribution. The student contribution from income on the FAFSA is calculated as a flat 50 percent of discretionary income. The parent contribution from income is calculated on a sliding scale, from 22 percent to 47 percent of discretionary income.
So, generally speaking, if you’re a dependent student, every $10,000 increase in your parent’s income (above the income protection allowance) will cause about a $3,000 decrease in need-based financial aid and every $10,000 increase in your income will cause up to a $5,000 decrease in need-based financial aid.
There are two income thresholds built into the federal financial aid formula. Reducing income below these dollar amounts can have a big impact on eligibility for need-based student aid.
In both cases, your family must also meet certain additional criteria:
It’s not always possible to reduce your income (and giving up your job isn’t really a good solution). But, there are some choices you (or your parents) may be able to make to reduce income — at least during your college years.
Starting with the 2017-2018 FAFSA and thereafter, the income you will report comes from what is called the “prior prior year.” The 2018-2019 FAFSA will ask you about income from your 2016 tax return, instead of your 2017 tax return. This makes it easier to complete your FAFSA, but it means that most of the strategies below won’t affect your EFC for the 2018-2019 academic year.
Good strategy: Avoid artificial increases in income
Bad strategy: Shifting income from adjusted gross income to untaxed income
For example, increasing contributions to qualified retirement plans (like a 401(k) or IRA) may decrease AGI, but the contributions will be added back in to the total income, counted as untaxed income.
If you use a professional tax preparer to file federal income tax returns, make sure the tax preparer is aware of the potential impact of tax minimization efforts on eligibility for need-based financial aid — especially if you are close to either of the income thresholds.
Sometimes, choices that reduce your tax liability have a much greater impact on financial aid eligibility.
For example, a tax preparer may choose to file an IRS Form 1040 instead of an IRS Form 1040A or 1040EZ to claim various exclusions from income. But, taxpayers who are required to file an IRS Form 1040, even if just to itemize deductions, may be ineligible for the simplified needs test and auto-zero EFC.
Similarly, a tax preparer may prefer the American Opportunity Tax Credit over the Tuition and Fees Deduction, since the direct financial benefit is greater, even though the tuition deduction may increase eligibility for financial aid by reducing AGI.
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