Late January means the start of tax season as many taxpayers begin to get their W-2’s from employers to start preparing for filing tax returns. For financial aid work, this means building and sharpening the skills you need to use tax return data efficiently to improve your financial aid decisions. But you don’t need to be a professional tax preparer (though that certainly helps a lot!) to get some key things right. Take these five steps to get you largely along the way to unpacking some of the most useful data from tax forms:
- Double-check salaries reported. Income is a key driver in calculating estimated family contributions (EFC). Using the 1040 and W-2’s be sure parents report their salary properly is critical. In addition to entering too many or too few zero’s in salary amounts, a very common mistake that families make on their PFS is to count their business profit as their salary AND to count it also as their business profit. If the amount listed for one parent’s salary is the same as the amount listed as business profit, that’s usually a reliable tip off that one or the other is not accounted for properly. Having a W-2 is the best way to verify if they’ve reported the salary correctly. If they paid themselves a salary from their business, they should have a W-2 for that amount. If not, they reported it wrong. Take it out of salary and recalculate the EFC.
- Take a stand on handling depreciation. With data captured from IRS forms Schedule C, Schedule E, Schedule F, and Form 4562, SSS can identify for you how much depreciation is being written off against a business, rental property, and/or farm. But it’s up to you on how to treat the depreciation expense. Do you want to add back the write-offs on tax forms that largely represent “paper losses?” Or do you want to provide business owners the same protection of the cost of business assets that the IRS allows? In the School Portal, you can set one of the Professional Judgment options to reflect whichever direction on depreciation you want to take. Determining your policy approach and setting it accordingly in the Portal will help ensure that EFC’s get calculated with your preferences in mind. For more on depreciation, watch the SSS recorded webinar “Appreciating Depreciation” in the Content tab.
- Mine the W-2s for nontaxable income. Not only do W-2’s show the amount of salary or wages a person received from an employer, it’s also a good source for verifying one type of nontaxable income that is often misreported by parents on the PFS: pre-tax contribution to retirement plans. An amount shown in Box 12 of the W-2 accompanied by a lettered code D, E, F, G, or H, reflects elective pre-tax contribution to some type of retirement plan. If not already reported by the parents on the PFS, include it and recalculate. With a W-2 submitted to SSS, School Portal will display any amounts reported on the W-2 to help you identify and match this with the PFS entry. Recalculate the EFC with this as nontaxable income if the parents didn’t report it properly on the PFS.
- Impute the dividend and interest income. Did you know you can use some tax data to help gauge if savings and investments data are being reported appropriately? Dividend and interest income on the 1040 can indicate the presence of assets that the parents may not have reported (or may have underreported). To estimate how much savings or investments they need to have to generate their interest and dividend income, divide the interest and/or divided income assuming a rate of return that might be typical. SSS defaults to use 1.2%, though schools can use any rate of return they like. So, if a total of $1,000 of interest and dividend is reported, imputing at 1.2% would mean the family needed to have about $83,000 ($1,000 divided by 1.2%) in savings and/or investments. Double-check to see if they reported assets in the ballpark of your imputed value on the PFS. If not, recalculate using the impute.
- Schedules matter. Be sure that you don’t only get the two-page 1040 for families. Get any schedules that they’re required to file with the 1040 as well. Without them you will be missing potentially important information. Perhaps the most important schedules to be sure you have, if applicable, include:
a. Schedule A showing itemized deductions: among other things, can sometimes include medical and dental expenses.
b. Schedule C for business owners with sole proprietorships: helps to see the income and expense details for the business, including depreciation write-offs.
c. Schedule D for transactions regarding selling assets: shows how much the parent sold the asset(s) for, which you might use to help determine if that should be considered cashflow available to them. If the family bought $12,000 worth of XYZ stock over time and sold it this year for $10,000, they report a $2,000 loss as income on their tax return BUT they have (or had) $10,000 in hand to use for spending. Should some of that be expected to go towards tuition?
d. Schedule E for rental real estate, partnerships, and/or S Corporations. Helps to see the income and expense details for the rental properties, including depreciation write-offs. If the family is involved in Partnerships and/or S Corporations, page 2 of the Schedule E will show useful general information about their participation in and income from those businesses. This is a good prompt to ask them for additional information such as Schedule K-1’s and the corporate tax returns to dive more deeply.
e. Schedule F for farm owners. Helps to see the income and expense details for the farm, including depreciation write-offs.
When it comes time to evaluate tax forms, there’s a lot to consider and it can be overwhelming. Focus on a few key things and have policies for the situations that matter most. Use the data capture and data verification features School Portal provides. Be sure to watch the “Spotlight” webinar recordings on key tax forms. And scan the “Reviewing Tax Forms” library in the School Portal Content tab to get other helpful resources, such as the Quick Reference Chart, which compares PFS items with where they appear on various tax forms. With firm policies in place and these tools in hand, you’ll be able to tackle the tax return task like a pro.