Adjusting the Untaxed Income to Achieve More Federal Aid

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Apart from the various taxable income, there are some other income that the IRS does not tax. But the colleges are not so kind hearted, as they still consider those income, and find ways of using them to decrease your financial aid. Let us discuss some forms of income that belong to the untaxed category:

  • Social Security benefits:
    There are certain Social Security Benefits that are not taxable. Any untaxed Social Security benefits given to the student directly or indirectly (to the parents for the student’s benefit), or any untaxed benefit given to the parents will no longer be required to be reported as untaxed income on the FAFSA. As these untaxed benefits are a part of the AGI, they will continue to be included in the federal formula and the institutional formula, and they will also affect your EFC.
  • IRAs, Keoghs, 401 (k) s, 403 (b) s, and Tax Deferred Annuities (TDAs):
    There are some alternatives for pensions and social security benefits, like the IRAs, Keoghs, 401 (k) s, 403 (b) s, and Tax Deferred Annuities (TDAs). The benefit of these programs is that, they shelter your money from tax until you retire, while reducing your tax bracket.

    There is no problem in saving a part of your regular income in the alternative retirement plans until the first base income year. But the contributions to 401 (k) or 403 (b) plans have to be listed in boxes 12a-d of the W-2 form, codes D, E, F, G, H, and S.

    A possible way of escaping from the situation is, if your contribution to these plans reduces your AGI to the mark below $50,000, which makes you eligible for the Simplified Needs test (SNT).

    IMPORTANT POINT: One should never think of hiding the tax-exempted interest income from the FAO or the college. The tax free interest income has to be listed on line 8b of the 1040 form. The tax laws keep on changing, and if a particular tax free investment becomes taxable the other year, you will have to show the substantial taxable interest income to the FAO.

  • There are some other untaxed incomes, like the worker’s compensation, veteran’s non education benefits, the Health Saving Account deduction, and living allowances paid to the members of the military and clergy, that cannot be adjusted much, but they have to be reported on the forms.
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