According to the current Department of Education’s (DOE) plan, starting sometime in July, the IRS and Department of Education systems will be exchanging information to make the process more efficient. This IRS data integration with Student Loan Repayment and FAFSA are part of the FUTURE Act and FAFSA Simplification. These changes were started a few years ago and are a modification of many outdated systems.
The upgrade was delayed once due to the additional need for technical infrastructure changes that were not initially identified. The biggest change, which has not received much press, is the importance of people’s tax filing starting with the tax year 2022 and forward.
Under the new rules, people’s tax information will flow directly into many of the DOE systems eliminating errors, complexity, and fraud. The problem that we are anticipating is that many people are unaware of this change and how it may impact their financial positions going forward. In addition, many tax professionals are unaware of the change. Due to many COVID special tax changes, it is difficult for tax preparers to stay on top of all of the changes.
IRS and DOE Integration Background
For years, many parents and borrowers have complained about the complexity of the FAFSA and Student Repayment process. Both of these systems are highly dependent on tax information as part of their calculations.
For years the IRS data was available to transfer to the FAFSA through a tool called DRT or Data Retrieval Tool. It is a manual request by the FAFSA submitter to retrieve the IRS data and copy it into the FAFSA. It has had some problems but has improved over the years. Starting on October 1, 2023, DRT will be replaced by DDX or Direct Data Exchange.
At the same time, more student loan borrowers are using one of the Income-Driven Repayment (IDR) methods to repay their loans. The IDR methods are required to use for the various loan forgiveness programs. The monthly payments are based on a borrower’s income and not the loan terms. IDR usage has increased by over 60% since 2016 and over 54% of student debt dollars are repaid using an IDR method.
During COVID an additional law called FAFSA Simplification was added under the CARES Act. This formalized more DOE changes and put a formal timeline in place. Over the past few years, we have seen annual changes to the FAFSA specifically to make it better and easier to submit.
Importance of 2022 Taxes to DOE Systems
With this new integration, many people are unaware of the impact this could have on their financial aid positioning or student loan repayments. This is especially true for student loan repayment borrowers since many have not had to make payments for over 3 years.
This article is one of the steps, we have taken to bring this awareness to both the public and financial professional communities. A simple adjustment in a borrower’s tax filing decision could be worth hundreds of dollars a month if not done correctly.
Another problem is the tax professionals’ focus is typically on keeping a client’s tax exposure to a minimum. Many are not aware of the increasing use and relationship between taxes and IDR repayment methods. This is especially true since the Federal National Forbearance has not required federal loan repayment since March 2020.
Here is a simple example of how big this impact can be. This is a married couple with two children. She is a schoolteacher with over $70K of student loans due to a master’s degree. He is a business manager with no debt and received a significant promotion in 2021 moving his income from $75,000 to $110,000. She makes $50,000. To date, they have filed their taxes as married and joint.
If the proper planning is done, this couple could save over $470 per month after paying the additional taxes by filing married and separate. See the Tax Filing and IDR Repayment chart detail below.
As you see in the example, that tax professional’s goal would most likely recommend to file married and joint to avoid the tax increase of $2,735. The informed borrower would need to understand their options to be able to justify the increase in taxes to reduce the student loan repayment payment by a net amount of $472 per month or over $5,600 annually. This example uses estimated tax and repayment generated by PayForED’s Student Loan Repayment system.
This is not the tax preparers’ primary goal since their focus would be to minimize the client’s taxes which they did. The issue is looking forward to when repayment starts. This IDR repayment borrower will see an increase of nearly $500 per month in their student loan repayment if the proper tax planning is not done.
IRS Data Integration with Student Loan Repayment and IDR Recertification Timing
As we enter this year’s tax season and repayment will start at worst by September 1, 2023, borrowers need to begin planning now, during the 2022 tax filing season. Another complexity is getting the right advice and understanding the timing of a borrower’s income recertification date. According to StudentAid.gov, income recertification will restart in February 2024. This is based on the planned repayment restart date and a 6-month recertification date announced on the Studentaid.gov website.
For borrowers who use an IDR method, this year’s tax planning is critical. For some, your income being used will be over 4 years old. This is why 2022 taxes are so important since many have had changes in marital status and income changes. Based on the new automation, a person’s 2022 taxes could be used as late as November 2024 based on their IDR Recertification date and tax filing strategies.
It is important to realize how some married couples may think that they would just amend their return from Married and Joint to Married and Separate and fix the problem. Within the tax code, you cannot amend and change Married and Joint to Married and Separate. As a result, this couple would need to pay the $804 a month until the next IDR recertification.
With the automation and IDR recertification restarting in July, this would be a significant problem for those who do not do the proper planning now.
IRS Data Integration with FAFSA
Even though the FAFSA does not become available until October 1 of each year, it uses a process called Prior Prior. This again was a change made a few years ago to simplify the submission process. To keep Prior Prior simple, it means the FAFSA will use the tax return information you should have filed by April 15 of that year.
As an example, when the FAFSA comes available on October 1, 2023, the tax data used will be for the tax year 2022. The tax year and school year do not match, so additional planning should be done.
For most people, this will have little impact except for families that are divorced or separated. With the automation, it is unclear to what level they will match the student and parent’s income. It has always been our recommendation that the parent’s tax return claims the student who is applying for financial aid. With this increased automation, we believe this becomes even more important.
Unlike the loan repayment, the college financial aid office can adjust but it may make it more difficult since now they would know both parent’s income and financial strength if this was a FAFSA-only method college.
Since 2018 under the new tax code, claiming the child does not have the same financial impact it did before that. Some older divorce agreements had rules on how the children would be claimed. In those situations, due to these changes, some adjustments may be required.
Another issue, especially for first-time FAFSA filers is it is a blind submission. What I mean by that is that the numbers imported into the FAFSA will not be displayed on the FAFSA or on the Student Aid Report. With the blind submission and other FAFSA rule changes it will be important for families to have a tool like our College Cost Analyzer to estimate their EFC or new term Student Aid Index (SAI) this fall.
As other FAFSA changes are finalized, we will be providing updates in future articles as part of the FAFSA Simplification rollout.
IRS Data Integration with Student Loan Repayment and FAFSA Summary
As you can see this simple integration change could create additional confusion when student loan repayment begins and when the FAFSA is submitted. With a great deal of focus being on the student loan forgiveness final decision, borrowers’ 2022 taxes may be overlooked. Currently, the expected Supreme Court decision is not until June and by that time many would have filed their 2022 taxes.
In preparation for the IRS automation, it is recommended that you do some additional planning on your 2022 taxes.