If you are depending upon need-based financial aid for college, you may be better off if your parents pay more taxes. The formulas used to measure your financial need allow for the subtraction of taxes paid from income. That means the more taxes your parents pay, the less income they have for consideration in the financial aid formula.
How the Fiscal Cliff Will Affect Eligibility
Financial aid eligibility is determined by a formula in which the cost of attendance is reduced by your expected family contribution. The more taxes your family pays, the lower the expected family contribution. If we do go over the fiscal cliff this December 31st, families will pay more taxes and college students will have a lower expected family contribution. In fact, the EFC will drop by around 47% for every dollar of extra taxes paid on the same level of income.
The Effects of the American Opportunity Tax Credit
One good thing about the EFC is that the American Opportunity Tax Credit is automatically figured into the equation, allowing students to qualify for more aid. When you complete the FAFSA and the CSS Profile, the two EFC formulas add the amount of the tax credit. This increases the amount of federal taxes paid, reduces the EFC, and increases eligibility for financial aid.
The Effects of Retirement Contributions
Many people make extra contributions to retirement plans in hopes that it will allow their students to earn extra financial aid. Unfortunately, it can have the opposite of the desired effect. All contributions made to a qualified retirement plan are added back to the amount of income with no tax paid offset. This can reduce the amount of financial aid for which the student is eligible. On the bright side, all money already in a retirement plan is left out of asset calculation and only the current year’s contributions will have a detrimental effect.
It is easy to see that there is much more to financial aid for college than simply filling out the FAFSA. As such, it is vital that students and their families know as much as possible about the financial aid process so they will be prepared to maximize their aid with the income and taxes that are applicable.