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FAFSA Changes Target Divorcees and Extended Family

The formula will change for families filling out the form beginning Oct. 1, 2022.

In my last column, I shared how your clients could be impacted by the upcoming changes to the Free Application for Federal Student Aid.

For some affluent and middle-income families, the elimination of a significant aid-eligibility break for households with two or more children in college will be a painful financial blow.

Today, I’m diving into other important changes that the massive legislation passed late last year will usher in. The changes will take effect for the 2023–2024 school year, which means the formula will change for families filling out the FAFSA beginning Oct. 1, 2022.

FAFSA Changes: Divorce and Separation

To understand what will be different, it’s necessary to know what the current rules are regarding who files the FAFSA when parents are divorced or separated.

Right now, the custodial parent is the one with whom the child has lived for the majority of a 12-month period ending on the day the FAFSA is filed. Let’s say a parent is filing the FAFSA on Oct. 1, 2021, for the 2022–2023 school year. You would look back to Oct. 1, 2020, to see where the student lived at least 50% of the time plus one day. While the rule seems rather strange, it really just boils down to where a child ends up sleeping most nights.

The custodial parent is the only one who shares their income and assets on the FAFSA. Savvy parents, in a position to exploit this rule, made sure that the child stayed the majority of the year with the lower-income parent with fewer assets. In so doing, the student could be eligible for more financial aid.

What parents often don’t understand is that with the current rules it doesn’t matter which parent provided the most financial assistance or which parent claimed the child on his/her tax return.

This arrangement, however, is going to change, and parents who are separated and divorced need to prepare. Because of the FAFSA’s use of prior-prior tax returns, the tax returns for 2021 will be used in determining who the custodial parent is for the 2023–2024 school year!

The new rule will make where a child physically lives irrelevant when determining who the custodial parent is for FAFSA purposes. Instead the custodial parent will be the one who provided the most financial assistance. This will typically, but not always, translate into who claims the child on their tax return.

The move is being made to better align the FAFSA with Internal Revenue Service rules. The IRS definition of support includes not just child support, but also the fair market rental value of housing and a proportional share of household expenses. Here is the IRS worksheet to determine support.

This change leads to a couple of questions:

What would prevent a parent (with cooperation from the ex) from claiming the child on their taxes even though they didn’t provide the most support. Would that make the child eligible for more financial aid? Or would the child support payments be a red flag in that scenario?

According to Mark Kantrowitz, a nationally recognized financial aid expert, the answer, to a certain degree, is yes. But, he added, most divorces are not amicable, and the parent paying child support often wants to claim the children as dependents because it reduces their tax liability. 

It is likely that the FAFSA will rely on tax returns to determine who the custodial parent is unless parents appeal based on something called the multiple support agreement.

A multiple support agreement is a document signed by parents regarding who financially support a child. The agreement can allocate who claims a child as a dependent without regard to who provides more financial support. It can also dictate that parents rotate providing financial support.

Technically, multiple support agreements are supposed to apply only when neither parent provides more than half support, but in practice, divorced couples use them even when one parent provides more than half support.

FAFSA Changes: Grandparent Giving

Another FAFSA change will make it easier for grandparents, aunts and uncles, godparents and anyone else outside the nuclear family to help with college costs without hurting eligibility for financial aid.

Currently, parents are supposed to share on the FAFSA if anyone outside the immediate family has kicked in money to pay for college costs. This financial assistance is considered the child’s untaxed income. The FAFSA assesses this untaxed income at up to 50%, which is a steep price. (The FAFSA has never penalized a student if grandparents or others have simply saved for a child’s future college years. It became an issue only when outsiders pulled money out and paid for college expenses.)

The FAFSA overhaul, however, will not consider whether grandparents or other well-wishers have helped defray college costs starting with the application for the 2023–2024 school year.

Student Loan Payment Waivers Continue

Though not part of the education-related legislation that was actually tucked inside the massive pandemic-relief bill, the continuation of student loan payment waivers is definitely noteworthy, especially for clients who have grown children who have student loan debt. 

In reaction to the pandemic, the federal government temporarily stopped requiring federal student loan payments. The waiver period was originally to end in September 2020, but it was extended to Jan. 31, 2021. President Joe Biden has now extended the payment waiver through Sept. 30, 2021.

During this waiver period, no interest will accrue on an individual’s balance. Because of this interest hiatus, it makes sense for borrowers who haven’t been impacted by the pandemic to continue to make payments.

Lynn O’Shaughnessy, a nationally recognized college expert, offers an online course—Savvy College Planning—exclusively for financial advisors. Click here to get Lynn’s guide, Finding the Most Generous Colleges. 

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