So, What’s The Simplified Needs Test?

Telling Tips is a series of articles from local experts to help you save money, make better decisions and plan for a better future.

The Simplified Needs Test (SNT) is question 34 on the Free Application for Federal Student Aid (FAFSA) form. The purpose of it is to determine whether assets will be counted or excluded in the Estimated Family Contribution (EFC) Calculation. The EFC represents the amount of money the government feels the student and family can afford to contribute toward his or her college education. Simply stated, the lower the number, the less you’re expected to pay. The best score possible is zero.

The question reads as follows:

34. If you have filed or will file a 1040, were you eligible to file a 1040A or 1040EZ?

This question is asking about your eligibility to file one of these short forms (even if you filed or will fill an IRS Form 1040).

According to the instructions:

Answer “Yes” if you:

• make less than $100,000
• do not itemize deductions
• do not receive income from your own business or farm, and
• do not receive alimony

Also answer “Yes” if you:

• filed a 1040 only to claim American Opportunity, Hope or Lifetime Learning credits and you would have otherwise been eligible to file a 1040A or 1040EZ, or
• filed a 1040 and were not required to file a tax return

Answer “No” if you:

• Make 100,000 or more per year
• itemize deductions
• are self-employed
• receive income from your own business or farm
• receive self-employment income or alimony, or
• are required to file Schedule D for capital gains

For more, click here [PDF].

What Are The Benefits Of Meeting The Simple Needs Test?

As explained above, the SNT affects the EFC calculation. Before we discuss the SNT, let’s talk more about the EFC. EFC is simple to understand. Let’s begin with defining “need”:

Cost Of Attendance

Less: Estimated family contribution

Equals: Your need

The higher the need, the lower the EFC.

A low EFC is good news. It means that the government feels that you can’t afford to pay college tuition. It translates into higher, needs-based federal and state grants, and subsidized Stafford student loans. Subsidized is good because it means that the government pays the interest while the child is in school. If your EFC is zero, you are in a position to receive the absolute maximum allowable financial aid.

Additionally, schools use this number as a guide to determine how much of a financial aid package they are willing to offer.

Think about it. Sometimes a child, whose family has a low EFC, can send their child to a very expensive school, because the school could extend a valuable financial aid scholarship package to the student based on the [low] EFC.

Okay. Now we understand how EFC affects how (and if) students qualify for financial aid. But how is the EFC calculated to begin with? This is where the SNT comes into play.

As mentioned earlier, SNT decides whether assets are included or excluded from the EFC calculation. Why is this so important?

Let’s go back to the eligibility guideline for the 1040A. Remember we said that the threshold for income is $49,000? Would that not mean that, theoretically, you can have $49,000 in interest income and $1 million in assets, and still qualify for federal financial aid, since the assets will be excluded?

This happens more often than you might think.

A perfect example might be a divorced mother living in the home she purchased while married to her children’s father. Now she files single, and has a much lower income. Most accountants would want to file a 1040 and itemize. But that might not be the best way for her to go in this situation.

It’s also critical to differentiate child assets from parent assets.

Assets are counted differently for children than for their parents. A whopping 20 percent of the student’s assets go to the EFC calculation, whereas it’s only 5.65 percent for their parents. Let’s say Mindy’s parents opened an account for her college tuition and saved $100,000 in her name over the years. The school would be expecting $20,000 of that money. The same money saved in her parents’ name would be $5,650. Big difference! Never put money in a child’s name if you expect to qualify for financial aid.

What about Coverdell Early Savings Accounts and 529 plans? That is another topic, for another time.

Moving along, remember we said that cost of college less family contribution equals student need?

Let’s take it a bit further and put it this way:

Parents’ contribution +

Student’s contribution from income +

Student’s contribution from assets =

Expected family contribution

Now it becomes clear why it’s better to exclude the child’s assets. So, basically, if parents of college students qualify for the 1040A or 1040EZ, they should use that form instead of a 1040?

As a general rule, this is correct in theory. However, each family is different, and so are their finances. It’s important to evaluate whether itemizing is best, or if there are any credits or deductions that can be taken on the 1040, as they could outweigh the benefit of financial aid.

Another possible consideration would be if the child is going to a local public state university or college, then it probably won’t matter, and 1040 would be best. If the student is applying to a private school, the tuition is going to be much higher. In this case, it would be worthwhile to investigate what kind of financial aid packages the schools tend to offer. Sometimes the wealthier the school, the better the scholarship is. It’s a lot of work, but getting that EFC down could save a family tens of thousands of dollars, and even hundreds of thousands of dollars sending their children to college.

Does The Same Go For The Students Too?

Many young students do not file a tax return, especially when they are still dependents of their parents. The rule (in 2012) is that if a taxpayer does not earn at least $9,750, they are not required to file. The FAFSA question states, “Were you eligible to file a 1040A or 1040EZ?” Being eligible is good enough. On question #34, don’t say “Don’t know.” Say “Yes.”

Are there any other things we should be concerned about in choosing the right tax form for college students and their parents?

As all good tax professionals know, the tax code is complex, and many factors can come into play on a return. Here’s an example: If there were state tax refunds available in previous years due to itemizing, a short form could trigger a recapture. However, there is no way to record it on a short form, and therefore, only a 1040X – an amended form – could solve the problem. The catch is that sometimes there may be AMT issues or other complications, so it’s not so simple. This could be an extreme example, but the idea is that a competent tax professional must make an evaluation before making any changes.

Additionally, IRS formulas are different than financial aid formulas, and choosing a tax professional who understands the differences can be paramount. With the cost of college skyrocketing to outer space, many parents who previously thought they would not qualify for financial aid often have a good shot at sending their children to a great school if they get the right advice.

Parents who are very serious about helping their children get the best education possible would do well to consult with a reputable college financial aid counselor who has an in-depth knowledge of tax (or vice/versa) in order to help plan ahead and devise the best strategy.

Kids are our future. Let’s send them to school!

Rivkah Schweke is a federally-licensed Enrolled Agent, admitted to represent taxpayers in all 50 states and abroad. More about the EA designation here. Rivkah specializes in college finance. Her office phone number is 718 467-3767, and she is providing advice on college financial planning in the offices of our regular Telling Tips columnist, Joe Reisman, at 2751 Coney Island Avenue.