filing-the-fafsa-2015-2016-edition

Filing the FAFSA 121
Optimizing Income
Avoid Artificial Increases in Income
The expected family contribution is heavily weighted toward income. A $10,000 change in income will
have a much bigger impact on eligibility for need-based aid than a $10,000 change in assets. So, it is
important to avoid artificially increasing the student and parent income during the prior year.
• Capital gains. Be careful about selling investments the year before the child applies for needbased
financial aid. Capital gains are included in adjusted gross income and can affect eligibility
for need-based financial aid. If the parents need to sell investments to pay for college costs, they
should either do this at least two years before the child enrolls in college (e.g., before January 1 of
the child’s junior year in high school) or offset the capital gains with capital losses.
• Retirement plan distributions. Retirement plan distributions count as income on the FAFSA and
should be avoided, if at all possible. There is no exception for hardship distributions, such as a
distribution to buy or repair a home, prevent foreclosure or eviction, pay for medical expenses or
pay for tuition. (The family could appeal to the college financial aid administrator for an adjustment
to income corresponding to the hardship distribution, but there’s no guarantee that the financial aid
administrator will make the adjustment.) The financial benefit of taking a distribution is often small
due to the combination of the tax impact and the financial aid impact.
• A tax-free return of contributions from a Roth IRA is reported as untaxed income on the FAFSA,
which has the same impact on aid eligibility as increasing adjusted gross income. If the student
or parents wish to take a tax-free return of contributions from a Roth IRA, they should wait until
after the FAFSA is filed for the student’s senior year in college. If the student will not be going to
graduate or professional school, there will be no subsequent year’s FAFSA to be affected by the
distribution. The distribution can then be used to pay down student loan debt.
• If the family converts a traditional IRA into a Roth IRA, they should appeal to the college financial
aid administrator to get the conversion disregarded as income, assuming that the full amount
of the distribution was rolled over into the Roth IRA. The U.S. Department of Education issued
guidance in Dear Colleague Letter GEN-99-10 to encourage college financial aid administrators to
make such an adjustment.
• One-time events. Receiving a bonus or exercising stock options can increase income in a way that
may not be reflective of the family’s ability to pay for college. While some colleges may adjust the
family income (but not assets) to exclude one-time events, some will not, especially if the event
was within the family’s control.
• Pass-through entities. Income received by a pass-through entity, such as a sole proprietorship,
partnership, S corporation or LLC, is treated as income to the owner(s) even if the money is
retained by the business to pay for future expenses. Small businesses owned and controlled by
the family may be excluded as assets on the FAFSA, due to the small business exclusion, but the