The True Cost of Higher Education

And the Role of FAFSA & Educational Tax Benefits...

The College Board reports that full-time students at private-institutions typically paid almost $44,000 for tuition, fees, and room & board during the 2015-2016 academic year.  That’s the average, so costs at some private colleges and universities were well over $50,000 annually.  Higher education at public schools was far less expensive, but in-state students still spent approximately $20,000, on average.  These costs are on the rise, so younger students can expect to pay even more when they arrive on campus.

Student Loan Debt Taxation & Restructuring Options

Now for the good news.  The above numbers are all published costs, sometimes known as the “sticker price.”  The College Board also provides net prices, which may be more indicative of actual outlays by parents and students.  The average net costs for public institutions falls from nearly $20,000 to just over $14,000; among private schools, the average net price drops from approximately $44,000 to $26,400.

Discounts & Taxes

What accounts for the substantial differences between published and net prices?  The College Board estimates grant aid and education tax benefits in determining net price.  Grant aid is mainly discounts from a college’s published price; education tax benefits are the amounts a family saves from tax credits and deductions.  Some students will receive more financial aid than others, while some families will receive more tax savings from education-related benefits.  The remainder of this post includes explanations of education tax benefits and opportunities for maximizing them.

Making the Most of College Financial Aid

In order to obtain financial aid, you should begin by filling out the Free Application for Federal Student Aid (FAFSA).  This is a complex form with many questions, but its purpose is to get a picture of a student’s family income and assets.  Some of the questions request tax return information.

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After completing the FAFSA, your answers go through a formula that determines your expected family contribution (EFC).  The lower your EFC, the greater the amount of financial aid a student may be awarded.  This number can change every year, so a FAFSA application generally must be submitted annually.  Potential financial aid awards are determined by comparing your EFC to a given school’s listed cost.

New Rules for the FAFSA

Starting in October 2016, new FAFSA rules go into effect.  Under the current process, including the one for the 2016-2017 academic year, the FAFSA could be submitted no earlier than January 1 of the coming school year.

Beginning in October, applicants will be able to submit a FAFSA for the 2017-2018 school year.  This shift in submission timing will require applicants to provide “prior-prior year” tax returns (i.e., returns filed two years prior to the start of the applicable academic year), rather than prior year amounts.  For example, a student applying for financial aid in the 2021-2022 academic year will report amounts from the 2019 tax returns submitted on an October 2020 FAFSA.

Planning Considerations

As previously mentioned, a lower EFC may result in increased financial aid.  In determining your EFC, income generally is the most important factor (assets count, too, but typically to a lesser extent).  As such, minimizing income can be beneficial for maximizing financial aid.  It is important to be aware of the peril associated with the “prior-prior year” tax reporting requirement: applicant’s income from two previous years will now be assessed in determining financial aid awards.  If you believe your needs have been underserved, you can request a professional judgment review by a college’s admissions office.

Higher Education Tax Credits & Deductions

In addition to financial aid, tax benefits can reduce the net cost of higher education.  Explanations of the three (3) primary tax breaks – American Opportunity Tax Credit, Lifetime Learning Credit, & Tuition and Fees Deduction – are provided below.

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American Opportunity Tax Credit (AOTC)

This credit was recently extended through 2017, and it typically serves as the most beneficial choice for parents of collegiate children.  The AOTC can produce the largest tax saving: as much as $2,500 per student per year.  Furthermore, the AOTC has the most generous income (phase-out) limitations.

The maximum tax credit is available to single and married taxpayers with modified adjusted gross income (MAGI) up to $80,000 and $160,000, respectively.  To receive the full $2,500 tax credit, your spending must be at least $4,000 of qualified expenses per student.  Qualified expenses include tuition and fees (but not room and board), course-related books, supplies, equipment, transportation, insurance, and medical expenses.

You can take the AOTC for each of the first four (4) years of a student’s higher education, but the student must be claimed as a dependent on your tax return to qualify.  If you meet the income limitation threshold, the American Opportunity Tax Credit is refundable.  In other words, if the credit reduces your income tax liability below zero, the remainder can be paid to you in cash.

Lifetime Learning Credit (LLC)

The income limits for the Lifetime Learning Credit are lower than for the AOTC, and the maximum tax savings is $2,000 per return (not per student).  The maximum tax credit is available to single and married taxpayers with modified adjusted gross income (MAGI) up to $55,000 and $110,000, respectively.  The LLC is set at 20% of the first $10,000 spent on qualified expenses for higher education.  Otherwise, the rules for this credit are similar to those for the American Opportunity Tax Credit.

If the AOTC is more advantageous, why would you use the Lifetime Learning Credit?  Because you may qualify for the LLC when the rules for the AOTC can’t be met.  For instance, the LLC is available for all years of higher education (as opposed to the first four years for the AOTC) as well as for courses taken to acquire or improve job skills.  The Lifetime Learning Credit can be claimed for an unlimited number of years, so it may be useful once you have exhausted the use of the AOTC (i.e., after you have claimed the AOTC for four years).

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Tuition and Fees Deduction

A tax credit is generally better than a tax deduction, so the AOTC or the LLC usually save more tax than the tuition and fees deduction.  If you don’t qualify for the tax credits, however, you may be able to deduct up to $4,000 of qualifying expenses from gross income.  The maximum deduction is available to single and married taxpayers with modified adjusted gross income (MAGI) up to $65,000 and $130,000, respectively.

Related Posts:  Student Loan Debt Taxation & Restructuring Options

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