Tax preparation and tax planning strategies are unfortunately often an after-thought by the taxpayer. What every tax professional detests is telling a client that had the client notified the tax advisor in advance of the financial action that was being contemplated by the taxpayer, rather than the tax advisor learning of the transaction when reviewing the client’s annual tax information to prepare Form 1040, the financial results of the client would have been vastly improved. All taxpayers should consider meeting at least annually with their tax professional to discuss planned financial transactions and how best to accomplish them. In other words, rather than thinking of tax preparation as merely an annual tax compliance function, it should be viewed as a strategic tax planning opportunity to reduce taxes or to increase financial wealth.
For example, let’s consider a scenario where grandmom (and/or grandpop) has contributed to the grandchild’s 529 plan. There is just enough money in the 529 plan to pay for one year of qualified educational costs. The parents apply for FAFSA financial support and are successful in getting financial aid. The parents are relieved to learn that the value of the 529 plan assets held by the grandparents is not includable in the financial aid application. The grandparent’s 529 monies are used to pay for the child’s freshman year expenses. The distribution would be considered non-taxable on Form 1040 since the funds were used to pay for qualified educational expenses.
All is well . . . or is it?
What happens in the second year when the FASFA application is made and the parents are counting on that financial aid? Most financial aid offices interpret the FASFA rules as requiring distributions from grandparent-owned 529 plans to be included as student income, even when the distributions are not reportable for federal income tax reporting purposes. Thus the distributions are considered as income to the student and in this scenario the student’s aid will be decreased or lost in year two. Now the parents are facing a financial hardship that had not been anticipated. Could the loss of the financial aid been prevented?
Yes, the above situation could have been prevented if the grandparent’s 529 plan assets were used to pay for the last year of college rather than the first year. In this scenario, the student would have received 4 years of financial aid and the income rule relating to the grandparent’s 529 assets would have been irrelevant since the student would not be applying for financial aid for the year following graduation.
If you want to learn more about your personal tax and financial strategies, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.