Families with college-bound students should buckle down and do their homework this fall, particularly if their children are entering high school. 

Those applying for financial aid for the 2017-18 school year will be permitted to complete and submit the Free Application for Federal Student Aid (FAFSA) as early as October 1, 2016, rather than having to wait until January 1, 2017. The application will now become available every October 1 to give families extra time to file.

In another policy shift, families will be required to apply for financial aid using what the industry refers to as “prior-prior year” tax returns instead of prior-year returns. Families must file the 2017-18 FAFSA using their 2015 tax return, the same as for the 2016-17 application. For students graduating high school in 2018, 2016 tax returns will create the baseline for filing financial aid forms.

“It’s a real sea change,” says Beth Walker, a financial planner with the Wealth Consulting Group, a Las Vegas-headquartered RIA firm, and the founder of College Funding Coaches, a firm that helps with all aspects of college planning. Parents must live for two years with the consequences of their 2015 tax returns, she says, and they need to understand how much earlier they must plan for the financial part of college. 

“They need to get a grasp on the financial realities [by] freshman year of high school,” she says. “Proactive parents should be looking at anything to change the outcome of their expected family contribution and aid eligibility.”

Walker, based in Colorado Springs, Colo., has directly helped more than 350 families with college planning over the past 12 to 15 years. She also helps other advisors with college planning for their clients. Walker finds most parents panic when they see the “astronomical and frightening” sticker prices of college. What they often fail to realize, she says, is that college costs are not necessarily all additional expenses.

“When you really start to do good cash-flow planning for college, that’s where you identify all the areas in a family’s life where some of what you’re going to spend on college is already baked into lifestyle,” she says. For example, a family may be supporting club sports or music lessons—expenses that often stop when a child goes to college. At that point, this money can be used to help pay for school, she says.

Another thing Walker says families often overlook is education tax credits. The most common one, the “American Opportunity Tax Credit,” provides a maximum annual credit of $2,500 per eligible student. It can be used to pay for tuition, certain fees, books and other qualified expenses during the first four years of post-secondary education. Room and board, insurance and transportation do not qualify.

The tax credit starts to phase out when annual family income hits $160,000 and is phased out completely at $180,000 (for a married couple filing jointly). Walker encourages business owners with higher incomes to consider putting their children on their payroll. If the children can demonstrate that they provide half their support through their own income, they can file their taxes independently and qualify for the credit. 

Tax Scholarship Plans

Walker recently implemented what she calls “a tax scholarship plan” for the three children of a physician and a business owner. “The kids are legitimately working in the business,” she says. “This is not just an accounting game.” They’ll receive annual incomes of $20,000 and benefit from “tax bracket arbitrage,” she says, because they’re taxed at a 15% rate instead of their parents’ 40%-plus rate. Additionally, she says, “they’re now eligible for the tax credit that mom and dad got phased out of.”

According to Walker, the family was able to redirect $7,907 per child toward college each year. Assuming each of the three children spends four years as an undergraduate student, this tax credit adds up to more than $94,000 combined. “That is huge,” she says. “[The parents] don’t have to go earn $1.40-plus to pay that dollar to the school.”

There are challenges with making kids independent tax filers. First, families can’t pinpoint how much income their children will have to demonstrate until they select a particular school. The annual published price tag can range from $24,000 for four-year public institutions to $68,000 for some private schools, notes Walker. Second, it can be tricky to pay children a fair wage that can be defended in an audit, she says. 

When Walker talks to business owners who’d need to pay their kids an annual salary of $20,000 to $30,000 or more, she encourages them to consider, “What value are they bringing to my business that I would pay that kind of money for?”

The first suggestion that comes to Walker’s mind is hiring a child to manage a business’s social media. When she has inquired about the cost of creating content and managing social media for her own business, marketing agencies have quoted her monthly retainers of $1,500 to $ 3,000. “That’s here in Colorado,” she says. “I can’t even imagine in New York or L.A. what it would cost.”

Alternatively, a family that owns a lot of rental real estate can make the children members of the LLC, says Walker. This enables them to earn income without having to prove what work they’re doing. She had a dentist who gifted his equipment to an LLC that was owned by his children. The dental practice rented the equipment back, which generated income for the children without having to put them on the payroll.

Which strategies may work appropriately “depends on the facts and circumstances of the family, and the way their income and assets are organized,” she says. “The one thing you always want to err on is that it’s by the letter of the law.” For example, a family paying their child needs to be paying that child’s payroll taxes. 

Walker encourages finding a CPA well versed in college planning who can create a blueprint that clients can take to their local CPA to execute. She describes the specialist as the architect of the tax plan and the local CPA as the general contractor. 

Focusing on 529s

Walker would like to see more employers offer 529 college savings plans as an incentive to get employees to save for college. “I think they’re one of the most underutilized employee benefits plans on the planet,” she says. If it’s passed, the Boost Saving For College Act, a bill introduced earlier this year that provides for an employer match, “can be a game-changer in the 529 space,” she says. 

The legislation, as written, would also allow excess funds to be rolled over into a Roth IRA, enable families with a disabled child to roll a 529 plan into an ABLE account, and provide a nonrefundable tax credit that acts as a savings match for low- and moderate-income families. 

Suzanne Shier, director of wealth planning and tax strategy for wealth management at Northern Trust in Chicago, also speaks to many clients about 529 plans, and she views them as a good multi-generational tool. She likes their tax advantages, flexibility and gifting provisions.

Married couples that take advantage of the accelerating five years of annual gift tax exclusions on the front end can gift up to $140,000 all at once to a 529 plan. Based on her calculations, $140,000 gifted to a 529 plan when a child is born can balloon to $473,191 by the time the child is 18. This assumes the portfolio grows at 7% per year and it’s a reminder, she says, to be aware of not overfunding a 529 plan. 

A nice perk of grandparent-owned 529 accounts, says Shier, is that the grandchildren can see what their grandparents have done for them. “There is a degree of appreciation, gratitude and relationship-building that can happen, particularly between a grandparent and grandchild,” she says.

Grandparents can also set aside trust funds to pay for college and graduate school expenses, says Shier. Although the trusts won’t necessarily have the same income-tax attributes as 529 accounts, the assets in the trusts can be invested to manage income taxes, she says.

Shier says growing college savings tax-free has become more significant as tax rates have climbed. When weighing tax-free and taxable accounts, she says families should consider their federal income tax rate, state income tax and the 3.8% net investment income tax if their modified adjusted gross income exceeds the applicable threshold ($250,000 for married couples filing jointly). All told, these taxes can add up to close to 50%, she notes.

Training Ground

In addition to crunching the numbers this fall, parents should be having conversations with their college-bound kids. “Use planning for college as an opportunity to introduce children to the concept of their personal financial management in a context that’s relevant to them,” says Shier.

She strongly suggests helping kids understand the costs of college. It’s also important to discuss whether the parent, student or both will be responsible for different categories of expenses such as tuition, room and board, health insurance, personal expenses, entertainment and clothing, she says. 

When her two daughters were still in high school, Shier taught them to start budgeting their money quarterly. “I wouldn’t say that either of my daughters were clotheshorses, but they found the sales rack at the department store pretty darn fast after the budgets started,” she says. One daughter ran out of money in high school a couple of times before the end of the quarter. Budgeting “was a very constructive experience in terms of them getting to college and not being overwhelmed or frivolous,” says Shier. 

The conversations shouldn’t stop once kids arrive on campus. A father she met at a recent work function sends his children, who are in college, emails every Monday morning that say, “Have a great week; let me know if you need anything; and school this week, by the way, will cost X dollars,” says Shier. “Kind of a reminder that we’re here for you and we want you to do what you need to be doing while you’re in school.” 

By the way, says Shier, a $60,000-a-year college costs about $400 dollars a day.