Strategies to Help Business Owners Survive the Cost of College
Everyone who has children is aware of the high cost of college. Over the last few decades costs have risen substantially faster than inflation. In-state tuition and fees over four years at the University of Tennessee (Knoxville)runs $22,488; for Belmont University $73,680; and for Vanderbilt - $133,760. This doesn’t include room and board. Is it any wonder parents get a knot in their stomachs when they think of college?
There are two ways of paying for college: with your money or someone else’s money. The main source of ‘other people’s’ money is through financial aid. Financial aid falls into the categories of gift or self-help aid and is based on financial need or merit. Many people assume they can’t qualify for financial aid for college due to their income or net worth. This may not be the case. Sometimes strategies can be employed that even help families with six-figure incomes qualify for financial aid. This brings us to our first college admissions Rule #1: Never assume you can’t qualify for financial aid. Always submit a financial aid application (called a FAFSA) when your child applies for college admission. It’s a good idea to consult with a college planning professional a year or more before college about strategies to improve your financial aid chances. There are many strategies to reduce the cost of college. I’ll focus on one approach I call the “tax scholarship.”
One of the largest overlooked costs of college is income tax. We pay for college with after-tax dollars. If you’re in the 25% tax bracket you would have to earn $170,667 before tax to pay $128,000 of college expense. That’s an added cost of over $42,600! Reducing any part of that tax cost creates a “tax scholarship”. So how do you do it?
People with businesses, highly appreciated assets, or those who own rental property are the best candidates for this type of planning. For example, assume you pay your 16 year old child $5,000 to work in your business. In 2006 your child would have no tax on the first $5,150 of earned income. He or she could then contribute $4,000 to a Roth IRA since IRAs are not assessed for financial aid. Penalty-free withdrawals can be taken in college for qualified expenses. Assuming you are in the 25% bracket, your “tax scholarship”, including self-employment taxes saved, is $3,562. Also, since your child is not over 18 years of age there is no withholding required.
Your business could also employ your child and reimburse him through a little-known tax rule that allows a business to assist with college costs. In the right circumstances, a business owner could pay their child over $10,000 tax deductible to the business and tax-exempt to their child!
Other college planning techniques to reduce taxes might involve shifting appreciated assets to your child and letting them realize the capital gains at their lower capital gains rate. With the passage of TIPRA in Spring 2006 a child must be age eighteen or older to avoid taxation of passive income at their parent’s rate. Also with TIPRA the capital gains rate for the two lowest tax brackets will drop from 5% to 0% in 2008. Other tax reduction strategies might be consolidating non-deductible debt payments into a home equity loan or shifting assets for college into tax-deferred vehicles which are not assessed for financial aid. These and other strategies can potentially result in tens of thousands of dollars in ‘tax scholarships’.
Finally, let’s not overlook the Hope and Lifetime Learning tax credits which can offset up to $2,000 in taxes per year. These credits are available to tax payers with Adjusted Gross Incomes of less than $110,000. This brings me to college planning Rule #2: don’t assume you earn too much to get these college credits. With planning many families are able to utilize the credits even though family income is much higher than the income cap.
Beware! A thorough knowledge of both tax law and financial aid rules is recommended when utilizing these types of strategies. It is possible to lose more in potential financial aid than is gained in tax reduction or vice versa. Rule #3: always use the combined expertise of your accountant and a Certified College Planning Specialist to avoid costly mistakes.
Author: Bill Garrett, President of Garrett Financial, LLC , a Member of the Paladin Registry