This week Gail discusses college loans, income tax & dependency status.
We have a son who is going to be a sophomore at the University of Dayton. He has a scholarship for $10,000 per year for 4 years. My husband and I have never really saved much for his education. We have agreed to pay $10,000 per year, as well, but he has to pay the rest. We have taken out parental Sallie Mae loans to cover our part of the bargain.
Would we be better off having him be independent, not declaring him, and taking the loans out as student loans?
First, I think you might be confusing declaring a child as a “dependent” on your income tax return with dependency status as it pertains to financial aid. These operate under two entirely separate — and completely different — sets of rules.
Joe Hurley, who runs the website www.savingforcollege.com, is a CPA. He points out that you “fail the dependency test” for income tax purposes if your child provides more than half of his own support for the tax year. Although this means you and your husband cannot claim him as a “dependent” on your joint tax return, your son could file his own tax return. By doing so, Hurley says he “would get his own personal exemption and a higher standard deduction.”
To do this, however, your son would have to have income and be able to demonstrate that he paid for more than half of his living expenses. I’m guessing that would be a stretch.
Meeting the requirement for “independent” status for financial aid purposes is actually tougher. Carl Buck is the Vice President of College Funding Solutions for Peterson’s, a company that provides information about college admissions and financial aid. He spent 30 years as a financial aid officer, so he knows the rules inside and out.
According to Buck, “The law says you’ve got to be 24 years-old or older to be declared ‘independent.’ ” The only exceptions are if you are a veteran, have a dependent yourself, are married, or have already received your undergraduate degree and are in graduate school.
Based on the fact that your son is entering his sophomore year of college, I’m betting he’s not 24 years-old yet.
In terms of what would be the most advantageous approach to financing his college education, parental loans (also called “PLUS” loans for “Parent Loan for Undergraduate Student”) carry a significantly higher interest rate than loans issued to students. “I urge the parents to take out a loan at the lower interest rate,” says Buck.
In other words, to the extent possible, try to finance your son’s college education with student, or “Stafford,” loans.
Your son can remain a “dependent” and still qualify for these loans. Even if you can’t come up with all the money you need, at least this will reduce the amount you have to borrow at the higher PLUS loan rate.
An additional bonus is that, unlike PLUS loans, re-payment of student loans is delayed until after graduation. It can be further postponed if your son attends graduate school.
Getting back to the income tax issue... Provided he can meet the “more than half his own support” hurdle, there’s another reason your son might consider filing his own income tax return: The Hope and Lifetime Learning tax credits. These are dollar-for-dollar reductions of your income tax bill.
The Hope tax credit is a maximum of $1500. It’s available for students who are in their first or second year of post-secondary education (college or vocational technology school). The Lifetime Learning tax credit covers years three and after, and can be as high as $2,000/year.
However, you lose these credits if your “modified” adjusted gross income (MAGI) exceeds certain limits. For 2005 the credits are phased out between $43,000 to $53,000 for single filers and between $87,000-107,000 for those filing joint. (These income limits are re-calibrated each year based on inflation.)
Hurley, who is the author of “The Best Way to Save for College,” says if you and your husband are not eligible for these credits because your joint income is too high, in all probability your son would be (assuming his MAGI didn’t exceed $53,000).
But be sure you run the numbers first. To start with, is your son’s income high enough to trigger income tax? There’s no “credit” if there’s no tax due. Second, which strategy results in the largest overall tax savings: Your son filing his own return or you and your husband claiming him on your return as a “dependent?”
Finally, Buck says even if your son files his own tax return, it won't impact whether he is eligible for Stafford loans.
Hope this helps,
I consolidated my student loans several years ago when the interest rates were in the mid-7% range. Is there any way to get a significantly lower rate, or can you only consolidate once?
I hate to be wishy-washy, but the answer is “maybe.” I’d need more information as to the type of loans you had/have and their payment status (grace, repayment, or default, etc.).
It’s definitely worth a try, since consolidation rates today are still below what you’re paying. A good place to start investigating this is the “FAQ” page of the Department of Education’s loan consolidation Web site: www.loanconsolidation.ed.gov/hfaq.shtml. There is also a link to an email address where you can submit your information and ask questions about your specific situation.
You might also want to read what I wrote about consolidation in my April 28th column, “Deadline Looms for College Loans.” [Click here to read the column.]
If you have a question for Gail Buckner and the Your $ Matters column, send them to: email@example.com, along with your name and phone number.