Paying for College Without Going Broke, 2017 Edition - Princeton Review, Kalman Chany (2016)

INSTITUTIONAL METHODOLOGY COMMENTS AND CASE STUDIES

Prior to the 2011 edition, we included worksheets to calculate the expected family contribution (EFC) under both the Institutional Methodology (IM) as well as the Federal Methodology (FM). Beginning with the 2011-2012 award year, as a change of policy the College Board is no longer providing anyone with their proprietary tables and formulas to calculate the IM EFC. However, they have agreed to provide us with EFC amounts for the IM under some common scenarios. But before we get to those case studies, there are some additional items to note regarding the IM:

While there have been adjustments for inflation and other minor changes, we assume there have not been significant changes in the standard IM for 2017-2018.

Many colleges that use the institutional methodology often tweak the formula, for example making adjustments for the cost of living for those families residing in high cost areas. So even though one used to be able to calculate an IM EFC, that number was never written in stone—and could differ considerably from school to school. In recent years, we have found that the packages from individual schools using the institutional methodology are varying wildly based on the ways their aid policies deviate from the standard formula. As such in the past few years, the standard IM formula had been less reliable as a tool for predicting one’s EFC at schools that use the IM than it had been in the distant past.

Websites that say they will give you a calculation of your EFC under the institutional methodology have not been very reliable in the recent past—and will be even less reliable this year.

For students whose parents are divorced, separated, or were never married, many schools that use the IM assess a contribution from both parents. This can result in a significantly higher family contribution than under the federal methodology which only considers the finances of the custodial parent who resides with the student.

So what’s a family to do? The basic strategies outlined in Chapter Three still apply full force; for example, high medical expenses will continue to reduce your IM EFC. At the end of this section, you will find a number of typical family situations. The College Board was kind enough to calculate the expected family contribution using the standard 2017-2018 institutional methodology for a number of common scenarios, along with a somewhat common institutional option for how home equity is treated. Along with the points below, this should give you a rough idea of what the IM EFC could be under these circumstances.

Item One: Additional Data Elements Considered As Income

The institutional methodology includes many untaxed income elements that are not assessed in the federal formula. See this page. However except for the Earned Income Credit, pre-tax contributions withheld from wages for HSA accounts as well as for dependent care and medical spending accounts, and untaxed social security benefits for family members other than the student, most of these additional untaxed income items under the IM do not apply to most families.

Item Two: Losses Claimed on Income Tax Return

Families who have significant losses claimed on their personal IRS 1040 tax return (for example: losses from property rental, S-corporations or partnerships, farming operations, or capital losses; or losses claimed on schedule C from self-employment) will find that their family contribution in the institutional methodology may be more than under the federal formula. Such losses can be a double-edged sword. For while these losses boost your income in the IM (compared to the FM), they also reduce the amount of U.S. taxes paid—which are a deduction under the formula.

Item Three: Higher Allowances Against Income

In years past, for most families, the income protection allowance under the institutional formula has been greater than under the federal formula. The same is true for the deduction for state and local taxes—which has been based on a higher percentage of one’s income. Combined with a somewhat higher maximum employment allowance as well as the granting of an Annual Education Saving Allowance, the IM’s higher allowances will normally result in a smaller contribution from income for most families than under the federal formula. Except, of course, for family situations when Item One and/or Item Two above apply.

Item Four: Additional Assets Assessed

The IM assesses certain assets that are excluded in the FM. For most families, this means the primary residence (i.e. your home). Yet while the standard institutional methodology considers the full equity in the home as an asset, in the past few years more and more schools have been treating one’s home equity in a wide variety of ways. While some still assess the full equity, others will only consider it if your income exceeds a certain amounts (in some cases, $150,000).

Other schools that use the CSS PROFILE (Hamilton College and Bard College come to mind) exclude home equity entirely. Still others view home equity on a case-by-case basis. For example, if you bought your home recently with a large down payment, some colleges might arrive at a higher family contribution than if you bought your home 25 years ago at a modest price but have since experienced significant increases in value that cannot be readily accessed.

So having significant equity in the home can be the “wild card” in how schools using the IM calculate your EFC. Your IM EFC may be less than the federal methodology or it could be significantly more, depending on a school’s policy. In the case studies that follow, we provide the IM EFC under two common ways that equity in one’s primary residence is treated: a) with the full equity considered and b) with the home equity capped at two times income.

Another difference between the institutional and federal methodology is that the equity in all businesses and farms is assessed in the IM, while any “family business” or “family farm” are excluded under the Federal methodology.

For the case studies that follow, the EFCs is first calculated when only one child is in college as a freshman. The changes to the EFCs when a second child is in college are also provided.

Case One

Typical family of four; a two-parent household living in Los Angeles, California, daughter starting freshman year, with a younger sibling age 15. The older parent is 55 years old. Both parents work. Their adjusted combined gross income is $175,000. The father’s income from work is $75,000; the mother’s $105,000. U.S. income tax paid in the base year: $22,850. The parents contribute $9,000 to a 401(k) plan plus $4,000 contributed pre-tax to medical spending accounts. There is no other untaxed income, and the family shows no losses on their tax return. They own a home valued at $600,000 with a mortgage of $150,000, so equity is $450,000. Excluding retirement accounts, the family has assets of $60,000 in cash, savings, checking and other investments. The family’s medical expenses are $9,000 for the year. The student earned $8,000 in the base income year and has no other income. She pays $170 in U.S. income taxes, and has $1500 in a savings account.

Results for Case One

EFC Federal methodology:

$43,962 from parents (PC) + $459 from student (SC) = $44,421 FM EFC

EFC Institutional methodology with full home equity considered:

$55,430 from parents + $3,749 from the student = $59,376 IM EFC

EFC Institutional methodology with home equity capped at two times income:

$52,927 from parents + $3,749 from the student = $56,676 IM EFC

EFC for an upperclassman with another sibling in college with full home equity considered:

PC FM: $22,707; PC IM: $35,487. (Same SC as above for FM and IM)

PC IM with home equity capped at two times income: $33,267 (2 in college)

Case Two

Father, aged 48, is a single parent; mother is deceased. His son is starting freshman year. There is another sibling, age 16, one year behind. They currently live in Baltimore, MD. The father’s income from work is $90,000. His AGI is $87,000. U.S. income taxes paid this year is $8,200. He contributes $4000 to a 401(k) and $2,000 pre-tax to a medical spending account. The father pays $3,750 for the family’s medical expenses for the year. He receives $8400 per year in social security benefits per child because of the mother’s death. There is no other untaxed income. Father has home equity of $260,000 ($350,000 value less $90,000 debt) and $25,000 in financial assets other than his retirement accounts. His son has no income, but has $500 in a savings account.

Results for Case Two

EFC Federal methodology:

$14,639 from parent (PC)+ $100 from student (SC) = $14,739 FM EFC

EFC Institutional methodology with full home equity considered:

$22,780 from parent + $2,125 from the student = $24,905 IM EFC

EFC Institutional methodology with home equity capped at two times income:

$19,920 from parents + $2,125 from the student = $22,045 IM EFC

EFC for an upperclassman with another sibling in college with full home equity considered:

PC FM: $7,950; PC IM: $14,497 (FM SC: $100; IM SC: $2,775)

PC IM for an upperclassman with another sibling in college with home equity capped at two times income: $12,781

Case Three

Two parent household in Brooklyn, NY. Daughter is starting freshman year, has two siblings age 14 and 10. Father is self-employed and his income from work is $130,000. Mother works part-time for someone else and earns $10,000 in salary. Mother is 49 years old, father is 46. Their AGI is $106,400. Father contributes $6,000 to a traditional deductible IRA, with no other retirement contributions made by the family. Parents’ U.S. taxes paid figure is $6,200. Home equity is $700,000 ($900,000 value less $200,000 debt). They also own a second piece of real estate with $200,000 in equity ($275,000 value less $75,000 debt) that generates a property rental loss of $5,000 in the base income year. They also claim a $3000 capital loss on their tax return. The parents have $10,000 in cash and investment equity; father has $150,000 equity in his Schedule C business (sole proprietorship). Family has medical expenses of $10,500 (not including the self-employed health insurance deduction). The student earned $4,000 and had no other income. Therefore, there are no U.S. income taxes paid. Student’s assets consist of $1,000 in a non-interest bearing checking account.

Results for Case Three

EFC Federal methodology:

$27,769 from parents (PC)+ $200 from student (SC) = $27,969 FM EFC

EFC Institutional methodology with full home equity considered:

$55,335 from parents + $2,250 from the student = $57,585 IM EFC

EFC Institutional methodology with home equity capped at two times income:

$32,375 from parents + $2,250 from the student = $34,625 IM EFC

EFC for an upperclassman with another sibling in college with full home equity considered:

PC FM: $14,401; PC IM: $33,914 (FM SC: $200; IM SC: $2,900)

PC IM for an upperclassman with another sibling in college with home equity capped at two times income: $20,153

KEY THINGS TO KNOW ABOUT THE IRS DATA RETRIEVAL TOOL AND THE IRS TRANSCRIPT VERIFICATION REQUIREMENT

If you’ve already filed a 2015 personal income tax return with the IRS (i.e. IRS form 1040, 1040A or 1040EZ), the online 2017-2018 FAFSA form, known as FAFSA On The Web (FOTW), may allow you to transfer some of your financial information directly from an IRS database using an option called the IRS Data Retrieval Tool (DRT).

While this tool has been billed as a way to simplify the FAFSA, some in the aid community believe its real purpose is to more accurately verify FAFSA information and prevent fraud. The DRT can be used when you complete the original FOTW or when you’re revising your FAFSA data - known as FAFSA Corrections - after your tax return has been filed. Since the DRT can be used after filing an original FAFSA, you should NEVER miss a FAFSA or other aid deadline if your taxes aren’t done or you are unable to use the DRT. Be aware that it will take a number of weeks - at least three if the return was filed electronically and up to 11 if the return was mailed - before the DRT can be used.

Determining if You Can Use the IRS Retrieval Tool

When using the interactive FOTW, the skip-logic built into the form may automatically disqualify you from using the DRT—for example if your marital status recently changed. Or (even more obviously), if your taxes aren’t yet filed or you’re not even required to file a return. This is no cause for alarm. Later in this section, we’ll explain what to do if you’re ineligible or unable to use the DRT.

But even when the FOTW tells you that you may be able to use the DRT, you’ll still have a few additional hoops to jump through. Once you click “Already Completed” for FOTW questions 32 or 80, then several “yes or no” questions may appear on your screen to further determine if the DRT can be used. A “Yes” response to any of these questions will disqualify you from using the tool at that time. (If not enough time has elapsed after filing the return, you can of course try again at a later date.)

But even if you answer “no” to all these questions and can use the DRT, there is one specific scenario when you should be extremely careful, if using the DRT. Namely, if you had a qualified rollover of funds from one retirement account into another (see this page and this page). In this case, using the tool could significantly reduce your aid eligibility as income NOT REQUIRED to be reported would transfer onto the FOTW. So if you have a qualified rollover, you will want to reduce the amount transferred by the DRT by the amount of any such rollovers. (See this page-this page)

If You Decide to Use the IRS Retrieval Tool

If you’ve gotten this far and decided it is in your best interest to use the DRT, the first step is to get directed to an IRS database by using your DOE FSA ID (see this page) and then inputting your address and other information listed on your most recent tax return.

After all that, you’ll be given information on how to transfer some of your tax return data that appears on a screen onto the FOTW. Unfortunately, it is at this stage that many of our clients have reported they’ve had problems. So don’t be surprised if the DRT doesn’t work at first asking.

If you’re having trouble with the DRT, here are some troubleshooting tips:

1)If you see an error message that there is no record of your tax return, it may mean not enough time has yet elapsed. In this case, first check to be sure the return was actually filed. This is particularly applicable if you used a professional preparer. Also, IRS processing can also be delayed if you owed taxes to the IRS when you filed or were a victim of identity theft.

2)Check that the pre-populated data on the screen is correct. For example, if you have an extremely long surname, the maximum number of characters listed for FAFSA 62 or 66 (which pre-populate on the DRT screen) are less than the number you can use on that screen - so add the additional characters. If there’s any mismatch with IRS data, you may not be allowed to proceed.

3)While you will told to use the address as it appears on the return, this may not work—since the retrieval tool uses the address in the IRS’ database. “First Avenue” could easily be entered by an IRS clerk as “1st Ave”. There can also to be problems if you recently switched accountants or started using new tax software and changed the way you list your address.

4)If you live in an apartment, there is a specific question on the DRT about an apartment number on your return. But if the apartment number appears as part of your street address and not in a separate apt. # response area, entering it in the apt # response area on the DRT - instead of as a part of your street address - will likely cause problems.

5)You may think you know the city in which you dwell, but alternate names used on your return can cause a mismatch with your IRS information. Also if the U.S. Post Office (USPS) recently changed your zip code without your moving, try the new zip code even if the old code is still on your return. (For help with the proper city and zip code, the zip code tool at www.usps.com will tell you how the feds know your city and zip code.)

6)Every character of your data must agree exactly with the IRS database. Exceptions: the symbol # and any dash in your address cannot be used.

7)If you filed a joint return with your spouse, are required to report both individual’s information from the return on the FAFSA and are having trouble with the DRT: try using the other individual’s FSA ID to access the tool.

Unfortunately with most of issues above, the DRT won’t tell you which data element you entered is the problem. So you may need to keep trying multiple combinations of data.

And even if you do get the retrieval tool to work, it will not answer all the income questions on the FOTW. So you’ll need to go back and answer those FOTW income questions that do not pre-populate. Be especially careful with FAFSA questions 44, 45, 93, and 94, since not all sub-parts of these questions pre-populate. Be aware that the “Income earned from work” amount that may appear on a screen prior to your transferring data onto the FOTW often is not correct. Refer to Part Three of this book as well the FOTW instructions for guidance when answering these questions on the FAFSA.

If You Are Unable to Use the Tool…

…DON’T PANIC. You’ll just have to use plan B. Here’s what to do:

Go back to the FAFSA form, answering the questions based on your tax return and our line-by-line comments in Part Three, as well as information that appears on the screen. Most likely the instructions for the FOTW will tell you which specific IRS line number from your tax return correlates with a particular FAFSA question.

Interplay between the DRT and Verification

If your aid application is selected for Verification (see this page), then federal regulations now require all tax filers whose information is reported on the FAFSA to provide the financial aid office with an official IRS Return Transcript - a document generated by the IRS which summarizes your federal tax return information. (Sending the aid office photocopies of your tax returns will no longer be acceptable for Verification as it was years ago.) Federal regulations further stipulate that the IRS Transcript requirement can be fulfilled by using the DRT. So for tax filers, the use of the DRT when you complete the original FOTW or submit a FAFSA Correction will be much simpler and more efficient than requesting an IRS transcript. Be aware, however, that some financial aid offices may still require an official IRS transcript even if the DRT was used.

If you are not able to- or choose not to - use the DRT, you can obtain an IRS Transcript by requesting one online at www.irs.gov or calling the IRS at 800 908-9946. Be sure you request the “return” transcript for the appropriate tax year - and not your IRS “account” transcript. It will take a number of days before you receive the transcript in the mail. If you had a rollover of retirement assets, be sure to write the word “Rollover” next to the applicable line on the transcript and provide the FAO(s) with supporting documentation regarding the amount rolled over.

As with the DRT, you’ll need to wait the same number of weeks after filing your return before you can request a transcript. An even longer time period will apply if an amended return was filed.