Do you know any small business owners with children and upcoming college tuition bills? I have a client who is in this position and asked me if there was anything that he could do to help ease the brunt from either a taxes or a total cost of tuition perspective. While my business has been providing small businesses with bookkeeping and CFO services for a number of years, this was the first time that I have been asked this question. With four children myself, it seemed like a prime time to research the subject of college tuition and how to apply for financial aid.
First off here are some very high level basics about how to apply for financial aid:
There are two financial aid applications. The FAFSA form is used for all public schools and many private schools and the CSS form is used by roughly 300 selective private schools.
When applying for financial aid, your net income and net worth (excluding retirement assets) are the key factors. The applications are slightly different with regards to how they calculate these two factors and while they are rather similar, it is well worth spending some time to understand the differences. For the purpose of this piece I will not be going into the detail.
The calculations for any given aid year look at your financial information for the prior tax year. So when the financial aid officer calculates for the freshman year, they will look at the tax year starting with January of the junior year of high school. Assuming a traditional four year college program, the last measurement period for financial aid will be the tax year ending December 31st of the junior year of college.
The good news is that small business owners have a number of options that can help, although they need to be used in a manner that doesn’t limit their opportunity to get financial aid.
Small business owners have much better control over income and net worth than traditional employees do. Starting in the tax year prior to freshman year, schools will look at your net income and net worth. It’s unlikely that an employee would be able to significantly change the timing of compensation, retirement contributions or other items related to the aid calculation but the small business owner can.
Net income can be significantly lowered by depreciation and other non-cash expenses in a given year. This is particularly true for real estate assets and investment properties. This is worth considering as you approach the beginning and end of the 4 year measurement period outlined above.
In determining net worth, there is a loophole where FAFSA doesn’t include value of small businesses (less than 100 employees) and for CSS where the value of your small business is included, valuations can vary significantly based on a number of different valuation approaches.
Employing your children and paying them a fair rate for the work performed brings a number of benefits in addition to teaching them the value of hard work and signaling to the college admissions officer that they are career minded.
- You can lower total taxes by putting a child on payroll, having them file a separate return, and getting an increased standard deduction.
- As an employer, you may not have to pay FICA or Medicare for family members under age of 18. This applies to both the employer and employee portion. This only applies if you are a sole proprietorship, single-member LLC or a spousal partnership.
- With earned income your child can fund an IRA. As an example of how meaningful this is, investing $5,000 per year in an IRA for the last three years of high school will leave them with roughly $380,000 at age 65 using a 7% average rate of return.
- If your children earn enough in college to supply more than half their cost of living (no longer a dependent) and is 21 or older, IRS Section 127 allows employers to deduct $5,250 of tuition assistance to an employee (tax free). Be careful so as not to compromise financial aid, see caveats.
Also as a non-dependent, The American Opportunity tax credit would lower their tax bill by $2,500 per year. Although this is not limited to small business owners, by being able to employ them and thereby helping them to earn enough to get over the hump, you have an advantage. In addition, as a non-dependent they qualify for 0% capital gains tax rate if taxable income is less than $36,250. This means that you could give them appreciated stock and have them sell it to pay for tuition. Again, pay attention to the caveats.
While shifting income is good on all four years since it doesn’t alter the total family income, Section 127 benefits should wait until after January 1st of junior year. Also it is always wise to consult your personal tax and/or financial adviser regarding any relevant strategies.
The Shared Finance Center provides outsourced accounting, bookkeeping and fractional CFO support to small business owners and in doing so we heavily focus on maximizing cash flow. We are headquartered in Roswell, Georgia and work with clients across the United States. If you think that this post would be helpful to anyone you know, please pass it along. Also please follow our blog for regular tips to grow your business.