The fiscal cliff – higher taxes may not be so bad if you’re seeking college financial aid

Politicians may be close to a deal that will avoid the dreaded fiscal cliff, thereby averting a $450 billion tax increase that would affect most American households.  However, if we find ourselves tumbling over the edge of that cliff on January 1, there is at least one possible silver lining for parents of college students.

Higher Taxes Can Increase Your Child’s College Aid Eligibility

Paying higher taxes can actually increase your child’s eligibility for need-based college financial aid. The reason is that in the formulas used to determine a student’s need for financial aid, federal, state and FICA taxes that parents and students pay get subtracted from their respective incomes. The more taxes you pay, the less income the formulas determine you’ll have available after taxes to contribute toward the cost of college. Depending on the cost of the colleges your child is considering, the child’s aid eligibility may go up because the child’s expected contribution will go down as the result of you paying more in taxes.

The Fiscal Cliff and Need-Based Aid Eligibility

Colleges determine your child’s eligibility for need-based aid by subtracting the amount you are expected to contribute toward the cost of attendance (cost of attendance – expected family contribution = need). The more taxes you pay, the lower your child’s expected family contribution (EFC). At colleges where the overall cost of attendance is higher than your child’s EFC, the child will qualify for need-based aid. If you end up paying more in taxes if we go over the so-called “Fiscal Cliff” when the Bush-era tax cuts expire this December 31st, then your child’s EFC will go down and aid eligibility at the colleges where your child qualifies for need-based aid will go up.

A simple rule of thumb is that your child’s EFC will drop by about 47% of every dollar you pay in additional taxes on the same amount of income.

Higher taxes may not be so bad if you’re seeking college financial aid, but they can be tough on  long-run economic growth.

Related:  How Would the Fiscal Cliff Affect Typical Families in Each State? (Tax Foundation)

Reminder – automatic zero EFC maximum income DROPPED TO $23,000

Last month Congress made it harder to qualify for an automatic zero EFC by reducing the maximum income allowed from $32,000 to $23,000 for the 2012-13 Award Year.  A zero EFC usually makes a family eligible for the highest amount of financial aid.

This significant change seemed to have stayed mainly under the radar, even though it will hit low-income families hard since over 4 million students qualify for the automatic zero provision this year.   Perhaps some provisions of President Obama’s 2012 “Blueprint for Keeping College Affordable and Within Reach for All Americans” will counteract this benefit cut to poor families.

Here are more details about how dependent students can qualify for the automatic zero EFC, updated from last year’s post.

For the 2012-2013 school year, a dependent student automatically qualifies for a zero EFC if both (1) and (2) … are true.

1) Anyone included in the parents’ household size (as defined on the FAFSA) received benefits during 2010 or 2011 from any of the designated means-tested Federal benefit programs: the SSI Program, the Food Stamp Program9, the Free and Reduced Price School Lunch Program, the TANF Program, and WIC; OR
The student’s parents:
• filed or were eligible to file a 2011 IRS Form 1040A or 1040EZ11,
• filed a 2011 IRS Form 1040 but were not required to do so, or
• were not required to file any income tax return; OR
the student’s parent is a dislocated worker.

AND

(2) The 2011 income of the student’s parents is $23,000 or less.
• For tax filers, use the parents’ adjusted gross income from the tax return to determine if income is $23,000 or less.
• For non-tax filers, use the income shown on the 2011 W-2 forms of both parents (plus any other earnings from work not included on the W-2s) to determine if income is $23,000 or less.

Federal Pell Grant Program of the Higher Education Act – Background, Recent Changes, and Current Legislative Issues  (pages 20 & 22)

Related:  Congress curtails Pell Grants and federal loan grace period 

Do you qualify for the automatic zero EFC loophole?

In determining eligibility for college financial aid, the lower your Expected Financial Contribution (EFC) the better position you’ll be in to receive money.  Even better than a low EFC is one that equals ZERO.

Some families can qualify for the automatic zero EFC “loophole” when completing the FAFSA, landing them in an ideal position for maximum benefits.  How do you qualify?  One common way is if your household Adjusted Gross Income is $31,000 or less and if you are eligible either to file the short tax form or no form at all.  Here are full details.

For the 2011-2012 school year, a dependent student automatically qualifies for a zero EFC if both (1) and (2) … are true.

(1) Anyone included in the parents’ household size (as defined on the FAFSA) received benefits during 2009 or 2010 from any of the designated means-tested Federal benefit programs: the SSI Program, the Food Stamp Program11, the Free and Reduced Price School Lunch Program, the TANF Program12, and WIC; OR
the student’s parents filed or were eligible to file a 2010 IRS Form 1040A or 1040EZ, they filed a 2010 Form 1040 but were not required to do so, or the parents were not required to file any income tax return; OR
the student’s parent is a dislocated worker.

AND

(2) The 2010 income of the student’s parents is $31,000 or less.
• For tax filers, use the parents’ adjusted gross income from 2010 Form 1040A or 1040EZ to determine if income is $31,000 or less.
• For non-tax filers, use the income shown on the 2010 W-2 forms of both parents (plus any other earnings from work not included on the W-2s) to determine if income is $31,000 or less.

Details that apply to independent students, along with other information about the EFC formula, can be found in THE EFC FORMULA, 2011-2012 document.

Some basics on how colleges use financial need in admissions decisions

Here are some terms used to describe the ways in which colleges may incorporate student financial need into admissions decisions.  This generalized information can serve as an introduction to a topic that comprises many shades of gray and is often confusing to families.

NEED-BLIND ADMISSIONS  –  Students are evaluated and admitted without regard to their financial need.  Virtually all public schools fall into this category and many private schools are mostly need-blind, but may use financial need to decide the fate of  borderline, wait-listed, international, or transfer students.  Additionally, this explanation by Mark Kantrowitz shows how the waters can be muddied by a school’s preference for wealthy students.

Need-blind admissions also doesn’t mean that the admissions is wealth-blind. A college might ignore financial need for low-income students, but then grant an admissions preference for high-income students. Most colleges define need-blind as meaning that financial need has no role in the decision to deny admission to low-income students. As such, financial need is not treated as a negative characteristic for low-income students. But colleges can treat a lack of financial need as a positive characteristic for high-income students and still consider themselves to be need-blind. For example, some need-blind colleges will admit full-pay but borderline candidates or grant wealthier students more attractive financial aid packages.

NEED-AWARE, NEED-SENSITIVE, OR RESOURCE-AWARE ADMISSIONS  –  A student’s financial need is typically considered in the school’s acceptance decision.  Enrollment management techniques are employed as a way to make sure the student body generates a sufficient  level of income for the school.  If you can pay your own way you are more attractive than a needy applicant, at least on that basis.  Consequently, a student who does not need financial aid may have an edge in getting accepted over an otherwise equally qualified student.  (“Need-aware” and similar terms are increasingly being used to describe many colleges that self-identify as “need-blind”, in the belief that only schools that ignore financial factors for ALL applicants are truly need-blind.)

FULL-NEED SCHOOL  –  One that claims to meet the student’s full financial needs, defined as the Cost of Attendance (COA) minus the Expected Family Contribution (EFC).  It is worth noting that many families are surprised to learn that the school’s determination of financial need is often lower than the family’s own assessment.  Also, the school may decide that a loan “award” will be used to meet all or part of the student’s need.

GAP STUDENT  –  Student whose financial needs are not fully met by the college.  The gap student is at higher risk for dropping out.

ADMIT-DENY ADMISSIONS  –  What “need-blind” actually means to a student unable to afford the college to which he was admitted.  If the school offers insufficient financial aid to cover the gap between the COA and the EFC, the student is effectively “denied” admission.

Your retirement savings are not included in determining EFC

Your 401k plans, IRAs, Keoghs and other qualified retirement savings are excluded when your Expected Financial Contribution* (EFC) is calculated using either FAFSA or PROFILE methods.

Saving for your retirement should be an important priority, and it makes sense that this portion of your financial pie is not “supposed to” pay for your child’s education.  In reality, many parents end up dipping into retirement savings to help pay for college.

* Expected Family Contribution (EFC)
The Expected Family Contribution (EFC) is how much money your family is expected to contribute to your college education for one year.
Typically, the lower your EFC, the more financial aid you will receive. Factors such as family size, number of family members in college, family savings, and current earnings (information you provide on the FAFSA) are used to calculate this figure.