Federal Income Tax Form Simplification Complicates FAFSA Form
Recent changes in federal income tax returns affect the Free Application for Federal Student Aid (FAFSA), starting with the 2020-2021 FAFSA. The 2020-2021 FAFSA, which families begin filing on October 1, 2019, is based on 2018 federal income tax returns, using income and tax information from the prior-prior year. The 2018 federal income tax returns replaced IRS Forms 1040A and 1040EZ with a set of schedules to IRS Form 1040.
Auto-Zero EFC and the Simplified Needs Test
Auto-Zero EFC and the Simplified Needs Test are simplified versions of the federal financial aid formula. Auto-Zero EFC sets the expected family contribution (EFC) to zero on the FAFSA. The Simplified Needs Test disregards all assets on the FAFSA.
In 2017 and earlier years, independent students and parents of dependent students could qualify for the Auto-Zero EFC and the Simplified Needs Test by being eligible to file IRS Form 1040A or IRS Form 1040EZ. This affected all FAFSAs through and including the 2019-2020 FAFSA.
But, IRS Forms 1040A and 1040EZ were eliminated in 2018.
The U.S. Department of Education decided to base eligibility on IRS Form 1040 Schedule 1 instead of IRS Forms 1040A and 1040EZ. If IRS Form 1040 Schedule 1 is required, the applicant is not eligible for Auto-Zero EFC and the Simplified Needs Test.
However, there are a few exceptions.
Exceptions to Schedule 1
If the taxpayer filed IRS Form 1040 Schedule 1 only to report one or more of the following, they remain eligible for Auto-Zero EFC and the Simplified Needs Test.
- Capital Gains (line 13 may not be less than 0)
- Unemployment compensation (line 19)
- Other income to report an Alaska Permanent Fund dividend (line 21 may not be less than 0)
- Educator expenses (line 23)
- IRA deduction (line 32)
- Student loan interest deduction (line 33)
The line numbers refer to line numbers on Schedule 1.
Potential for Confusion
The switch from IRS Forms 1040A and 1040EZ to IRS Form 1040 Schedule 1 are potentially confusing for two reasons.
First, the change represents a polarity shift from the taxpayer being eligible to file IRS Form 1040A or IRS Form 1040EZ to the taxpayer not being required to file Schedule 1. Although one could argue that it is a shift from IRS Form 1040 not being required to IRS Form 1040 Schedule 1 not being required, that isn’t the way it was presented to applicants.
Second, there are a half dozen exceptions that may affect an applicant’s eligibility for Auto-Zero EFC or the Simplified Needs Test.
When Is Schedule 1 Required?
The reason for the focus on Schedule 1 is to prevent taxpayers from manipulating their income to qualify for Auto-Zero EFC or the Simplified Needs Test.
Ignoring the six exceptions, Schedule 1 is required if the taxpayer is reporting additional income or an adjustment to income.
Additional income includes
- Taxable refunds, credits, or offsets of state and local income taxes
- Alimony received
- Business income or (loss)
- Other gains or (losses)
- Rental real estate, royalties, partnerships, S corporations, trusts, etc.
- Farm income or (loss)
- Other income (other than positive Alaska Permanent Fund dividends)
- Capital losses
Adjustments to income include
- Certain business expenses of reservists, performing artists and fee-basis government officials
- Health savings account deduction
- Moving expenses for members of the U.S. Armed Forces
- Deductible part of self-employment tax
- Self-employed SEP, SIMPLE and qualified plans
- Self-employed health insurance deduction
- Penalty on early withdrawal of savings
- Alimony paid
Note that if a taxpayer had to pay an early withdrawal penalty for cashing in a bank CD early, they are required to file Schedule 1. Accordingly, the family is not eligible for Auto-Zero EFC or the Simplified Needs Test. That doesn’t seem fair.
A good place to start