Having assisted many clients prepare for their children’s college education and having a daughter who’s fast approaching college age, I thought a general discussion on the topic would be informative. I’m not going to review all the different tax credits and tax related issues involved, due to the fact that they are ever changing. However, in my discussion I will hit on areas which have caused taxpayers problems due to misunderstandings or not understanding the law. But, first, the College facts.


2009/2010 School Year College Facts (Source: www.collegeboard.com)

1. Average annual four-year private college tuition and fees is $26,273.
2. Average annual four-year public in-state college tuition and fees is $7,020.
3. Average annual two-year public college tuition and fees is $2,544.
4. The average annual surcharge for out-of-state tuition is $11,528 at a four-year public college.
5. With room, board, books, supplies, transportation, and personal expenses added in, the annual cost is $19,388 for a four-year public in-state college that includes $8,193 for room and board, $1,122 for books and supplies, $1,079 for transportation and $1,974 for personal expenses.

If you’re like me and a number of my client you’re worries regarding college begin on the way home from the hospital. I began by thinking, “I need to find a way to start setting more money aside.” By all means this should be a concern. As shown above, the cost of a college education is expensive and is going up every year. I began to set money aside before my daughter’s first birthday. I also enlisted the help of my family and my in-laws by asking that some holiday gifts be given as US Savings Bonds and cash which could be put in a savings account on my daughters behalf.

One mistake parents make when saving for a child’s college education is they save for college in lieu of saving for retirement. Most financial advisors I know feel this is a mistake because there are fewer years to save for retirement after the child’s education is complete and you will not be able to make up the shortage in retirement savings. Personally, I believe you need to find a happy medium between the two. My Wife and I have retirement savings and we’ve saved for our daughter’s college education.

One recommendation I make to all my clients when discussing college is to consider a community college for the first two years. Many of New York’s Community Colleges have full credit transferability to most, if not all, of the state’s four-year universities. I first would make sure that you plan for the four-year University before committing to the junior college. The reason this makes so much sense is that for half the cost of one year at a Public four-year state college your child can complete two years of community college. There are other obvious advantages as well.

The next topic that parents don’t understand is financial aide.

Most colleges use the Federal Methodology (FM) for calculating the EFC from the household and financial data on the student’s Free Application for Federal Student Aid (FAFSA) form. The formula for this calculation was developed by Congress and defined by statute.

1. 50% of student’s income – AGI plus untaxed income and benefits less income protection allowance less deductions for certain taxes;
2. 20% of certain student’s assets;
3. 22%-47% of parents’ income – AGI plus untaxed income and benefits less income protection allowance less deductions for certain taxes, less employment expense; and
4. 2.6—5.6% of certain parent’s assets less asset protection allowance.
5. Other things to note regarding the EFC calculation are:

a. Income is based on the year before financial aid is needed (September 2009 financial aid is calculated using 2008 income tax return).
b. Assets are valued on the date the form is signed. Prior or subsequent fluctuations typically have no impact.
c. The cost of college is a critical factor. College cost must be greater than EFC.
d. Many private institutions use a variation of the Federal Method, referred to as the Institutional Method (IM). The Profile Form is administered by the College Scholarship Service. The IM takes a more thorough look at your income and assets to determine what you can really afford to pay. Some of the key differences in TM as compared to FM are:

1. There is no income protection allowance for the student’s income.
2. Personal residence equity is included in the parent’s assets.
3. Losses from Schedule C, D, E and F are disallowed in calculating income of the student or parents.
4. Students and parents are assessed at a slightly lower rate.
5. Assets of the student’s siblings are included as assets of the parents.
6. Income protection allowances, asset protection allowances, and tax paid allowances are different.

The two factors that you should gain from this information is 1) make sure the students income is as low as possible the year before college and 2) reduce the students assets to zero the year prior to applying for financial aide. If the parents can defer some of their income to after the college years that would help as well, but this is not easy to do.

Now for a couple of tax tips. First, if you are divorced or are getting divorced the parent paying for the most of related college expenses should be allowed to claim the child as a dependent and thus would most likely qualify for any credits available. Second, student loan interest is only deductible if the loan was used for qualified education expenses, can only be deducted by the person liable for the loan and the deduction is not available for Married Filing Separate returns or individuals claimed as a dependent by another. Lastly, interest on Educational Savings Bonds are nontaxable when used for qualified education expenses. However, the note must be in the name of the parent, the student named as beneficiary, and the parent must be 24 years old or older at the time the note is created.

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