Spring, 2011

Some (Just Some) of Our Challenges
We in financial aid are well aware of the inequities surrounding the use of the federal income tax – or rather, selected items from it – as the basis of the federal need analysis system. They are grist for discussions at professional meetings; they appear on FINAID-L. We are disturbed because, most of all, as professionals, we want to see that deserving students get the money they need to attend college.

The tax return contains incentives promoting certain behavior (purchasing, investing, owning) that make our way of life better. How many people would start small business or have rental property without these incentives? The whole system of deductions from adjusted gross income, credits against taxes to be paid, and refundable credits encourages and rewards certain types of behavior.

Our goal is to determine how much a family can contribute to education. We rely on the tax return as a representation of income because it is a document that is common across all segments of society and, while perhaps limited from our point of view, it has a degree of reliability since taxpayers are usually intimidated by the IRS. But it means that families can complete the FAFSA truthfully, and we can gasp.

Simplification has come to mean relying on a minimal number of items from the tax return. But, while the FAFSA becomes “simpler” the requirements for verification and the resolution of conflicting information become more complicated. What is simple for families to complete can become a verification maze as we seek to make sense of what we see and families try to give us what we want. We are not expected to be tax experts, perhaps, but we are expected to be the next best thing. A page of questions determines the student’s dependent or independent status, but it can result in financial aid counselors wading into areas best addressed by attorneys in family court.

As we verify some items to the nickel, large areas are almost ignored. Verification Worksheets include children who are well advanced into adulthood and not listed on the return as dependents. The status of “other family members” can be even murkier. The issue of divorced parents is especially problematic, with “advisors” telling parents to “just check ‘divorced’” on the FAFSA.

Tax Data: A Beginning
Initially the downloading of data from the tax return may create more questions for us to resolve than it answers. Students who have passed verification with paper returns in the past may not because the downloaded return differs from what we have seen in the past. We will have to incorporate the tax transcript into our operations for families choosing not have data downloaded. Then there are the families that download the data but change it. They will be flagged with a big flag. We will have much work, in conjunction with the Department of Education, in smoothing out the bumps in the process. But I believe that we can look forward to developing and refining the system for the future. It can work for everybody’s advantage, ours, students’, and the government’s.

Tax Data: The Future
The download of information from the tax return can advance Financial Aid in several ways. First, it can be used to populate items on the FAFSA, relieving families from completing many questions on the FAFSA and us from verifying the data. The IRS could cooperate and make a special line-item for rollovers, a common reason for verification problems. IRA and SEP plans could be considered untaxed income right from the return.

The W2s show the income earned by each tax-filer and the tax-deferred retirement and compensation amounts. If W2 information on pensions in Box 12 could be loaded into the aid application, it would make a major component of untaxed income readily available on the FAFSA and automatically accurate.

Second, as we all know, the tax return contains numerous deductions from AGI, credits against taxes paid, and refundable deductions. They are source of significant confusion for aid professionals, and families themselves are probably puzzled about what to include on the FAFSA. Using the data on the tax return, the federal government can itself decide what counts and what doesn’t count as untaxed income, and the download can populate the appropriate fields, leaving families less confused and us with less detecting to do.

A third possibility is probably more futuristic and more complex to work out. The federal tax return contains a great deal of information, and some of it could be used to improve the federal methodology, making it more reflective of ability to pay. Interest and dividend income can be used to check the accuracy of asset information, and in fact assets can be imputed from these sources of income. Income earned abroad might be treated as what it is: income.

It is relatively easy with the tax data to not permit losses to reduce Adjusted Gross Income. Although this would not be easy, formulas can be developed to derive the income level necessary to pay for the various itemized deductions are Schedule A. Fewer inconsistencies between lifestyle and eligibility for the Pell Grant would haunt us.

There are many possibilities to be considered and discussed for migrating data and defining how the data will be used.

The federal government, through its databases, would bear primary responsibility for determining eligibility for its programs. The system would largely “self-verify,” with financial aid professionals entering the picture in limited circumstances, for professional judgment (e.g., the death of a parent) or further verification (e.g., dependents in college). Instead of being mired down in as much detail, we might be able to spend more time doing what we do best: help students and parents pay for educational expenses.

The system that I envision might be relatively complex from the perspective of data and methodology; but, from the perspective of the family, it would achieve the goal of simplicity. The download would have to be required, not voluntary, and a close working relationship between IRS and DOE would be necessary for optimal operations.

Non-filers
Families supported through public programs now qualify with minimal questions, as they should. This status should continue with any verification of eligibility for public programs done through the databases of the programs. Programs granting assistance are all data-based now. It is a matter of linking those databases.

Institutional Methodology, Profile, and Tax Data
An improved federal system will help all aid offices. It can simplify verification and settle what counts/doesn’t count in the confusing area of credits and deductions. If improvements extend to tightening loopholes in the methodology, colleges relying on FM only should encounter fewer cases in which they shake their heads.

For IM colleges, it will help the workflow regarding federal records and might lower the number of times that students are eligible for full Pells but no institutional aid and the need to explain to families why this is so.

An improved federal system will be a better complement to institutional methodology but will not replace institutional methodology for the many colleges and universities that use IM. These colleges have significant grant budgets and assist large number of middle-income students. As a colleague once observed, the finances of present-day middle class families can be as complex as those of the wealthy fifty years ago.

The federal system envisioned here will not substitute for institutional policies that define income, assess the value of assets including the primary residence, and determine the ability of the noncustodial parent and international families to pay. Business add-backs often extend past netting losses to zero, and families with businesses and trusts are often asked to submit the tax documentation and trust agreements as part of the aid application. Items on the Profile show who is enrolled in postsecondary school and where that enrollment is occurring.

Institutional methodology also factors cost of living into calculation of family contribution which a national system created by Congress seems to be unable to do. Other special options are available for taking private school expenses and medical expenses into account. Special circumstances and questions specific to institutions are key parts of institutional methodology that a federal system could not be expected to address.

Details and More
Many details about the use of the tax return need to be worked out. If the process extends to methodology and/or assumptions about income level, it will take a great deal of time and effort to develop consensus on these matters. The calendar year of the tax return will never fully reflect our academic year.

The download can significantly simplify the way families apply for federal aid. Families will have less reason to pay for services such as filing the FAFSA.

The devil is always in the details, and there are many to work out. Could we eliminate the FAFSA? The answer is probably “no.” The FAFSA requires data that do not appear on the tax return: for example, the number of dependents in college, vacation properties (unless also rentals), the myriad of questions relating to dependency. Eliminating the FAFSA completely would mean that Congress would have to make changes that might not be politically palatable. Making even the modest changes might not be acceptable.

As financial aid resources shrink, we must strategize on how to use existing dollars to aid students who really need the money. This is an important social goal, and it is also the goal of our profession. In order to encourage students to apply for aid, we must keep the system simple from their perspective. But as a friend once said, “simple” doesn’t mean “simplistic.” The smart use of tax data could offer us a way to achieve better outcomes in federal aid. If aid dollars continue to decrease, it could help insure that the truly needy receive the funds. If funding grows at a later point in time, a better methodology opens the possibility of needy students receiving more funding or adding needy students who are one rung up on the economic ladder.

These are thoughts worth having and ideas worth exploring as a profession. As a soon-to-be retired aid officer, I leave them largely to the aid professionals and government officials who will carry on the good work of Financial Aid.