Many people need to realize how important this year’s tax filing decision is with the new IRS data integration and the Department of Education’s (DOE) systems. The implementation is complete and the DOE has started to use the data functionality. Before this year, it was optional, but for FAFSA, it is mandatory. We believe the IRS integration will become mandatory for specific student loan repayment methods within the next 6 – 18 months.
This IRS data integration with Student Loan Repayment and FAFSA are part of the FUTURE Act and FAFSA Simplification. FAFSA changes started a few years ago and are modifications to many outdated systems. A technical delay occurred due to infrastructure issues. The most significant change, which has yet to receive much press, is the importance of people’s tax filing decisions each year.
Under the new rules, people’s tax information will flow directly into many DOE systems eliminating errors, complexity, and fraud. The problem is that many people need to be made aware of this change and how it may impact their financial aid positions in the future. Many tax professionals need more knowledge of these new requirements but have been overwhelmed with COVID-19 tax 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 systems are highly dependent on tax information as part of their calculations.
Before this change, the IRS data was available to transfer to the FAFSA through a tool called DRT or Data Retrieval Tool. It was a manual request by the FAFSA submitter to retrieve the IRS data and copy it into the FAFSA. It has had some matching problems but has improved over the years. On October 1, 2023, DRT was 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. Most of the federal loan forgiveness programs require the use of an IDR method. The borrower’s tax-reported income determines the monthly payments, 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. The new SAVE repayment option exemplifies the move to IDR programs.
During COVID, the FAFSA Simplification law was added under the CARES Act. This law 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 more accessible to submit.
Reasons Why Your Tax Filing Decisions Impact FAFSA and Student Loan Repayment
Before this integration, your tax filing decisions were less important for FAFSA submitters and student loan borrowers. The previous process allowed people to submit the information manually. The manual process is no longer available for FAFSA and is planned to be phased out in the repayment process.
Before FAFSA Simplification, if parents were married and were completing the FAFSA for a dependent child, only one parent was required to sign the FAFSA. With the new rules, if the parents have filed married and separate, each parent will be required to sign the FAFSA and get an FSA ID. The parents need to do this because the new FAFSA will directly import the IRS data. In this case, there would be two separate tax returns. Each FAFSA contributors need to opt into using the IRS data or the FAFSA will not be processed.
There are also several reasons why your tax filing decisions are important for your student loan repayment planning. The National Student Loan Forbearance extension delayed the mandatory income verification for student loan borrowers. We anticipate that the IRS-mandated feed-to-loan repayment will be required in the next 6 – 18 months.
In anticipation of this possible DOE change, we believe borrowers should understand the future impact of this year’s tax filing decision. For student loan repayment, those who use or plan to use IDR methods, it has a direct impact. These borrowers’ repayment amounts will be directly related to the AGI amount on the current tax return on file.
The immediate impact for borrowers in repayment is now. Starting 3/1/2024, income recertification will restart. It was delayed due to the National Forbearance extension. Borrowers need to understand their income recertification date and how it relates to the tax information on file. Currently, borrowers can use alternative income certification methods, a manual process. If the IRS mandate goes into effect, then your tax information will be used.
As I mentioned above, the timing of the repayment start and the tax information on file becomes essential for people entering repayment later this year. This situation would typically be recent college graduates or the parents of recent graduates with Parent PLUS loans. Both groups will be entering repayment in November or December of 2024. If you are in this situation and the DOE mandates the IRS data, this could limit your repayment options or increase the payments significantly.
A critical factor is that most tax advisors must be aware of this integration. It often goes against the tax professional’s primary goal of lowering taxes. Many need to be mindful of the increasing use and relationship between taxes and IDR repayment methods. This relationship is especially true since the Federal National Forbearance has not required federal loan repayment since March 2020.
IRS Data Integration with FAFSA
Even though the FAFSA is delayed, your 2022 tax filing decisions are impacting your FAFSA for this year. It uses a time process called Prior Prior. This change simplified the submission process, which happened a few years ago. To keep Prior Prior timing simple, the FAFSA will use the tax return information you should have filed by April 15 of that year.
For example, the current year FAFSA should have been available on October 1, 2023; the 2022 tax data it used. The tax and school years do not match, so proper planning is required.
Now that repayment has restarted, more parents are also in repayment. Many are moving to the IDR methods to lower their payments. As a result, the married couple may be submitting married and separate tax returns. This tax decision will require both parents to get FSA IDs and sign the FAFSA. Under the old method only one parent needed to sign the FAFSA.
For divorced and separated families, we recommend that the parent submitting the FAFSA should have the child listed on their tax return as a dependent. Under the new FAFSA rules, the parent providing the most financial support should be the FAFSA-submitting parent. This decision may not always be the custodial parent. It may cause additional problems determining In-State tuition since the tax filer may reside in a different state.
Since 2018 under the new tax code, claiming the child does not have the same financial impact it did before. Some older divorce agreements had rules on how the children would be claimed. Due to these FAFSA changes, some adjustments may be required.
With the new FAFSA processing, it can be challenging to understand your Student Aid Index or SAI. The SAI replaced the EFC or Expected Family Contribution. The SAI is the resulting number from completing the FAFSA. It is now a blind submission, meaning you cannot see the numbers imported into the FAFSA form.
This SAI number could be much higher than expected for first-time FAFSA filers, and you cannot verify the numbers. With the blind submission and other FAFSA rule changes, families must have a tool like PayForED’s College Cost Analyzer to estimate their EFC or new term Student Aid Index (SAI). Only the college financial aid officers can see and verify the income numbers imported.
Tax Filing Decisions’ Impact on Student Loan Repayment
Many borrowers are new to the process, with the student loan repayment restart being delayed multiple times. We have also seen an increase in the usage of IDR. The problem is that many borrowers need to pay more attention to the complexities of these methods. It is currently optional to depend on the IRS data but some form of income needs to be provided, such as a paystub or W2.
The IDR methods offer significant benefits to the borrower. It allows their payment to be based on their income and not the terms of the loans. The IDR methods are also the methods a borrower needs to use for most loan forgiveness plans, especially the Public Service Loan Forgiveness (PSLF) plan.
Here is a simple example of how significant this impact can be with proper planning. For our example, we will have 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 2023 moving his income from $75,000 to $110,000. She makes $60,000. To date, they have filed their taxes as married and joint.
If the proper planning strategy is followed, 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 is to file married and joint to avoid the tax increase of $2,735. The informed borrower would need to understand their options 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 strategy differs from the tax preparers’ primary goal since they would focus on minimizing the client’s taxes, which they did.
IRS Data Integration with Student Loan Repayment and IDR Recertification Timing
As we enter this year’s tax season, many borrowers still need clarification with their current payments. Starting on March 1, 2024, income recertification will restart. Many IDR borrowers’ payment amounts are based on their income from Pre-COVID. If a borrower had a significant change of income or a tax filing status change, their payment could go up significantly if the proper tax planning is not done.
Understanding the timing of a borrower’s income recertification date and getting the correct advice is critical. Most borrowers depend on the loan servicers for their repayment advice. Due to the increased complexities and their legal restriction, the loan servicers cannot provide any tax or personal financial advice. This lack of information puts the consumer at a disadvantage.
For example, in the case above they filed their taxes as Married and Joint and then discovered the opportunity. A simple amended tax filing to Married and Separate would fix the problem. The problem is that under the current tax code, you cannot change Married and Joint to Married and Separate. You can amend Married and Separate to Married and Joint. Look at the chart above; this couple must pay the $804 a month until the next IDR recertification.
IRS Data Integration with Student Loan Repayment and FAFSA Summary
As you can see this simple integration change could create additional confusion with student loan repayment and FAFSA submissions. Hoping the loan servicer can provide this advice will not work since they are legally not allowed. The new IRS integration will require better tax advice for lower repayment and SAI numbers.
In preparation for the increased use of the IRS automation, it is recommended that you do some additional planning on your 2023 taxes. This planning will help families and borrowers understand Student Loan Repayment and the FAFSA submission. PayForED has a series of educational articles about Student Loan Repayment and the FAFSA submission, as well as a list of advisors with this expertise.
