THE BLOG

What Will Your "College Tax" Be?

04/19/2012 04:39 pm ET | Updated Jun 19, 2012

You're ready to file your federal, state, and local taxes. If you've got a college-bound student, however, you're not quite finished calculating your total tax burden, yet. There's one more federal form you'll need to fill out: the FAFSA (Free Application for Federal Student Aid), which will determine the size of your family's college "tax" bill.

What's a college tax? Well, it's the amount of money the government decides you will be expected to pay for college based on your reported financial information. The more you earn and save for college, the higher your college tax will be. That's probably why Zac Bissonnette, author of Debt Free U, quipped that FAFSA really stands for "Federal Assault on Families' Savings Accounts."

The FAFSA form is required for all families applying for financial aid. Once you complete it, just like with your taxes, it tells you how much you owe -- in this case, for tuition. To arrive at your college tax, the faceless bureaucrats behind this form don't just want to know how much you earned last year; they also want to know what you, and your child, are worth. This goes far beyond what the 1040 evaluates. Get ready to pull even more financial files and to divulge even more personal information than you do each year around April 15th.

The parallels to tax planning don't end there. The American tax code is now so complex that most families have to hire an accountant to help them figure it out. Because you have to file taxes every year, over time you become familiar with the basic rules of the American tax system, if not every last detail.

Most people have a passing understanding of how income taxes work, but don't understand the financial aid tax system at all, because it's not an annual event. It's a bridge we cross, unprepared, when we come to it. For most people, it will be a shocking rite of passage.

If you had a good income the year before your student enters college, then the FAFSA form is going to assess you a higher college tax, even if you were unemployed the two previous years. If you scrimped and saved to set aside money to prepare to pay for college, the FAFSA raises the price and raids your assets, which might make you wonder why you didn't just spend that money, since you're going to lose it anyway.

Imagine for a moment that the grocery store operated this way. You go in to buy a carton of eggs, but the price is not fixed. The clerk cannot tell you how much it will cost until you first divulge your income and net worth. If you are high income or have a sizeable savings account, the carton of eggs costs you a lot more. If this is how college pricing operates, why not the grocery store?

When it comes to college costs, the more a family saves, the more the college tax system will charge. In other words, it penalizes savings. This makes college tuition a fast-moving conveyer belt for those in the middle class, who cannot comfortably afford the listed tuition prices at most schools. Low-income families have a low college tax, and will receive financial assistance. High-income families have a high college tax, with the means to pay it. Those in the middle classes will find, however, that the more they hustle to meet the high price -- by working more hours or saving more money -- the higher the price goes, always out of reach. The financial aid system treats them like Tantalus, hopelessly trying to reach for a piece of fruit above or a drink of water below. These are the people who, ironically, sometimes earn too much to afford to send their child to the college of their choice, because they are considered too affluent to qualify for aid but do not make enough to pay the full price without taking a huge hit to their standard of living.

Your best bet in minimizing your college tax is to learn as much as you possibly can about the college financial aid system and how the FAFSA tax system functions. There are some assets and forms of income that count against you much more highly than others in this calculation. You need to know what financial factors count in your favor and which are going to count against you when it is college tax time. The more you understand about the financial aid system, the less you will pay for college. Failing to study the system, and to structure your finances defensively, is like failing to take the deductions you're entitled to on your income taxes. It can be a very costly mistake.