I have a confusing situation compounded by a divorce, and only a few weeks left in the year to figure it out.
My parents set up a nice little UTMA for my kid; it has now grown to about $60K. I spoke with a HEFAR financial adviser who told me that 25% of the UTMA would count toward our EFC. However, if we were to liquidate that and put into a fund under my name, only 5% would count, which is a $12K difference. Significant!
The issue is the cap gains tax. The HEFAR guy guessed it would cost around $3K, but said he wasn’t a tax person and I should ask mine. I don’t use a tax person and I don’t claim my kid; my ex does. So I called my ex’s tax guy who very nicely answered my general questions. However, the info he gave me seems to contradict what I’ve been otherwise told. Here is what he said:
If my kid files as an independent, that will reduce the EFC. I have heard otherwise. (Can my kid file as an independent? If so, won’t the FAFSA still want my tax info?)
Assuming a 15% federal and 6% state tax rate, selling off $60K would cost us $12-13K. (Would all of it really be taxed?)
I am now thoroughly confused. If tax guy is right, there is essentially no benefit to liquidating. We should sit tight, take our lumps, and be grateful for generous grandparents. However, I am not confident that he is right.
The only legal way I know of to have this money count as a parent asset for your FAFSA EFC is to liquidate the UTMA and invest the funds in a student-owned 529 account. You can’t just take this money and put it in a fund in your name, because, you know, it’s not your money.
Do you mean file financial aid paperwork as an independent? Vey likely that can’t be done.
You’ll only be taxed on the gains, not on the whole amount, and since it’s your kid’s money it will be on your kid’s tax return (the kiddie tax will likely apply, however).
You’ll have to run the numbers under different scenarios. Is liquidating and taking the capital gains hit worth the lower asset assessment that would apply to a 529 account?
Sorry this is complicated, and for the divorce. That is never easy for anyone.
It seems to me that the tax guy may be right, but the benefit in liquidating is for the future years. You have to look at this over the full 4 years - not just this one year.
The UTMA in your kids’ name becomes 25% for the first year, then again in the next 3 years after that, so taking the hit this year in taxes means a wash this year, but you have additional savings after that as for the next 3 years it counts as your asset instead of his, so it is included at the lower parent rate when included for EFC.
However, the other complicated part of this is the fact that having higher capital gains this year means your overall income is increased a LOT this year, so your EFC may go up.
Even if the kid files independently - which is questionable as he is getting support from his mom, and presumably from you as well - as I understand it, many schools will still need to see both parents tax forms.
Given the magnitude of the dollars involved, it might be worthwhile to pay for a tax advisor this year, as there may be other issues not mentioned that could also be affected by the choices you make. In my mind, I think you may need to sit down with a professional, make informed decisions, and potentially take action before 12/31.
I believe a 529 in the child’s name is calculated differently on the CSS profile (not sure if you’re applying to any school that uses the profile).
This year will actually count twice for income because they are changing the FAFSA/CSS profile tax years. This year will use 2015 and next year will use 2015. The year after that will use 2016. The double year for 2015 is because they are changing the rules started next year to use what they call “prior prior” tax returns.
Ooh, this is helpful! Okay, here’s a bit more info: my kid is a community college transfer student, so we’re looking at two years, both of which will be based on the 2015 FAFSA. Tax guy said nothing about the standard deduction, even though I asked him about the benefits to spreading it out.
Also consider if all these financial gymnastics are worth it. Need based financial aid is driven primarily by income. IF your child would not qualify for need based FA anyway, it might not make any sense to transfer $$, take tax hits for little or no difference.
You might want to run some Net Price Calculators (NPC) at some target schools both ways (UTMA as child’s asset and as 529 account (calculated at parent asset rate). For FAFSA only schools, you will need income and assets of custodial parent. For schools requiring FAFSA and CSS profile, typically income and assets of both custodial and non custodial parent (and any new spouses) are used to calculate the potential aid package your child may be offered.
It depends on how each individual school that uses Profile wants to do it. Some will consider student-owned 529s to be a parent asset (like FAFSA does), and some will consider them to be a student asset.
In that case, you really want to try and reduce 2015 income (or at least don’t do anything to increase it). Liquidating the UTMA after December 31 will keep all of that capital gains income out of 2015, and as long as your child graduates in spring of 2018, it will never be reported as income on a financial aid form.
Assuming your son is a senior now, his 2015 tax return will be used for both the 2016-2017 FAFSA and CSS, and the 2017-2018 FAFSA and CSS. Therefore, generating capital gains in 2015 will be counted in an additional financial aid cycle.
One idea would be to liquidate zero by December 31, 2015, and then liquidate some or all in 2016 and put the proceeds in his 529 before the day the FAFSA is submitted in early 2016.
Also note that unearned income (capital gain) is taxed at his parent’s rate. Without more information (basis, FMV, parent’s marginal rate, child’s earned income) it is unknown whether there is much of any benefit to split the sale between two years and have the FMV of the unsold UTMA assessed 25%, versus 5.6% after the allowance.
All these financial gymnastics may have no effect on receiving need-based aid. Many missing pieces - would the student be Pell-eligible? Is either parent earning above $50k? Other kids in college? FAFSA only school?
the custodial parent income and the student income is used on the fafsa only. Not the noncustodial parent. Custodial is defined as the one he lived with most the year prior to filing. It has nothing to do with who claims taxes etc.
students cannot file fafsa as an independent until they are 24 or married or some other more rare situations. This has nothing to do with how student files his taxes.
many private schools want both parents income, many publics don’t, check each college.
Only the amount of the unearned income above $2,100 (for tax year 2015) is taxed at the parent’s rate, right? So if the asset was sold over multiple tax years, each year the child could take advantage of 0% tax on the first $1,050 of gain, the next $1,050 of gain taxed at the child’s rate (presumably 10%), and everything more than that taxed at the parent’s rate. Of course, if the child also has dividends and/or capital gains distributions to report, maybe none of this would make much difference anyway.
Good catch - it depends - for example, the parent’s rate on qualified dividends and capital gain income is 0% up to the combined income with the child of $74,900 (where the MFJ marginal rate of 15% ends).
So if MFJ parents had taxable income of $70,000, the child could have qualified dividends and capital gain income of $7k ($2,100 + $4,900) and would have a zero tax liability.
Again - none of the financial gymnastics and time/money spent with a CPA on tax projections may matter if the child would not get additional need-based aid.
Agreed. Also, there are too many facts that we don’t know, as has already been pointed out, in order to provide any kind of conclusive advice: basis, FMV, parent’s marginal rate, child’s earned income, dividends and capital gains distributions that the child already has, etc.
OP: take all your information to a trusted financial professional who knows tax law and financial aid.
Our EFC, if the UTMA were to be in my name, would be under $8K. With my kid still in possession of the UTMA, that would go up to more than $18K. So who owns the asset will make a BIG difference to the EFC, and given the schools we’re looking at, the need-based aid would be significantly affected.
So even with the additional taxes, it makes sense to switch ownership - with my kid’s permission and assistance, of course. I will then keep it in a separate account to be used only for college expenses. Nobody will have no cause to sue!
I got a bit more information from the HEFAR guy today. Liquidating this year would result in capital gains income which would have to be reported on the FAFSA for this year. Since 2015 will be counted twice, and since my kid is a transferring as a junior, 2015 is the only year that will end up mattering. So it makes sense to wait until the beginning of January.
It turns out that liquidating will result in about half of it being taxed. Both my ex and myself will probably have lower income in 2016 compared to 2015, so hopefully by waiting the gains will be taxed at a lower rate.