“Our advisor told us college is expensive, that we won’t qualify for any financial aid and to just be happy we can pay for it.” — J&B K, Florida Business Owners, July 2018
Business owners experience countless success penalties as they grow their company and their net worth. Paying too much for their kid’s college education often falls into that category. But financial advisors can and should put an end to this defeatist attitude and become a super hero for their clients.
Business owners—and their team of advisors—assume there isn’t much opportunity to “buy college” at a discount so they do what most productive, successful clients do—they work harder or longer and pay for it because they think there are no alternatives.
“Parents who are small business owners have additional college funding tools available to them that other families don’t have,” says Jodi Eramo, CPA. Eramo is a leading expert for Tax-Advantaged College Strategies (TACS) and has taught hundreds of CPAs and financial advisors how to help business owners send their kids to college by leveraging the income tax code, not the financial aid system.
The purpose of tax-advantaged planning is to increase family funds available for future college costs by reducing taxation. Every dollar that can be redirected from making a tax payment and pointed toward a college cost is a win for the family. Counter to typical financial aid optimization strategies that avoid putting income or assets in the student’s name, tax-advantaged planning embraces those opportunities.
The progressive nature of the U.S. income tax system leaves the door open for “income shifting” within a household and can provide some meaningful benefits for the family when it comes to paying for college. Demonstrating “half of their support” is the code’s threshold for allowing any student to come off mom and dad’s tax return and file independently. When that happens, the student is taxed at a much lower tax bracket and becomes eligible for some tax credits that successful business owners lose once they’ve passed the $180k adjusted gross income threshold.
This is very straightforward during the college years because the college provides an annual cost-of-attendance cost schedule and typically sends an award letter outlining how much the student is expected to pay for each school year. As an example, the published cost-of-attendance for Drake University is $43,869. Assuming Drake offered our client’s student a $6,000 merit-based scholarship (reducing the overall cost to $37,869), “half of their support” would mean that student earned at least $18,935 and filed their own tax return, falling into the 10 percent tax bracket after the $12,000 standard deduction for single filers. Now add the education tax credit that mom and dad can’t qualify for and the student ends up paying zero taxes on that income. Recognize, however, that the student is still considered a dependent for financial aid purposes (a perfect example of why parents get so confused by different rules and planning priorities).
This is a much better outcome for the household overall and freed up all $18,935 to go toward paying Drake’s tuition, fees and room and board. Yes, there may have been payroll taxes so this isn’t without drawbacks or expenses but business owners understand there is a cost for doing anything that results in paying less taxes.
And let’s not forget that when a student earns more than half of their support they escape the kiddie tax rules—meaning appreciated assets can be gifted to them, resulting in even further tax savings through lower capital gains tax rates. This powerful combination can result in substantial savings for successful business owners that thought they had no alternative but to pay retail for college.
The most common question posed by CPAs is “how can we justify paying a student $18,000 or $22,000 per year to arrive at that half of support figure and justify them filing independently?”