Base Year Tax Planning

What is the “base year?”

When most parents think about tax planning for college, they are thinking about educational tax credits and tax deductions, which may include the American Opportunity Tax Credit, the Lifetime Learning Credit, 529s, tax deductions on tuition, and tax deductibility of student loan interest. You will claim these on your tax return during the years that your kids are already in college; but what’s also important to understand is the base year. Often times, parents don’t know this term in regard to educational financial aid.

So what is the “base year?” The base year is the tax year that is looked at by colleges and the government to determine qualification for financial aid. It is income from the base year that is input into the FAFSA (Free Application for Federal Student Aid). The base year starts January 1 of the student’s junior year and goes through December 31st of the student’s senior year in high school.

It’s important for parents to understand this because it sets the standard for financial aid for all four years. If parents can lower income and assets on paper during this base year and the student receives a better financial aid package as a result, then parents just set the standard for all four years. Typically offers will be renewable for the 2nd, 3rd, and 4th year if a certain GPA is met. Federal and State grants and loans offers may change in later years, but commonly, the college awards are not as aggressively tested in later years. This is why the base year is weighed so heavily and why it’s so important.

Base year planning involves keeping certain income and deductions items off the tax return in the base year in order to increase financial aid eligibility. But base year planning isn’t for everyone. One of the first steps in your family’s college planning process is to evaluate whether you may qualify for financial aid. Many colleges have generous endowment funds, so more families qualify for some of that money than they think. If there is a chance that your child may qualify for financial aid, you need to do base year planning early.

The purpose of base year planning is to minimize income but maximize the tax paid. Below are a few financial strategies that could increase financial aid when you file the FAFSA.

  • Minimize taxable income. Think twice before selling investments in taxable accounts. Realized capital gains on investment sales are included income. Avoid taking taxable withdrawals from retirement accounts and delay exercising stock options. Also, defer any bonus income until a later year, if possible.
  • Maximize taxes. No one wants to pay more taxes, and I am not suggesting that. What I am suggesting is to shift itemized deductions into non-base years if possible. This may mean instead of donating to a charity in your base year, donate twice as much during the year before or after. Another example is paying property tax or mortgage interest in the month before or after the base year to shift deductions out of the base year and thus shift taxes paid into the base year. Contributing to a 401K or IRA during your base year may hurt your qualification because you will pay lower taxes that year. Consider contributing more in the year before your base year.

The financial aid process is full of complexity, but if you take the time to plan and research, you’ll find that financial aid also offers a lot of opportunities to pay for student’s college education.

Listen to this broadcast on YouTube (Part 1Part 2) with guest guest Jodi Eramo, CPA, CCPRS with College Planning Relief® (CPR).

Photo Credit: SashaW

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