Is college financial aid included in modified adjusted gross income?

Health insurance agents sell health insurance. We don’t actually perform the medical services covered by the policies we sell. For medical care, our clients go to doctors and other health care professionals who spent years studying their craft. And when patients need health insurance advice, those same professionals should direct their patients to a knowledgeable, experienced agent for help. Insurance, too, is a profession, and the advice we give is not common sense.

The funny thing, though, is that insurance agents regularly give other types of advice – generally legal and tax advice – that should probably be reserved for professionals in those fields. Of course, we don’t really have a choice – our clients have questions, and if we want to make the sale, we better find the answers. Unfortunately, the answers aren’t always that simple, and we need to be careful in how we word them.

At HPA, as you can imagine, we get these sorts of questions all the time – questions that seem to have a simple answer but ones we’re not completely comfortable answering because a lawyer or CPA would throw in a lot of disclaimers, fine print, and “yeah, but”s if they were answering the questions.

Here’s an example. Last week we received a voicemail at the office from an agent in Wisconsin:

I’ve got a client that has two grandsons in college. They’re getting financial aid and they’re going to be applying for Affordable Care Act coverage and wanted to know if their financial aid would count as income with regard to the premium credit. I believe it’s just W-2 income but I’m not sure. Could someone find out?

The simple answer is no – financial aid, whether loans or scholarships, generally isn’t included in modified adjusted gross income when determining eligibility for a premium tax credit. The problem, though, is with the word generally. The longer, 3,000 word answer is below. If you truly want to answer your client’s question correctly, this is probably the answer you should give.

(Scroll to the very bottom for the takeaway from today’s post.)

FROM HEALTHCARE.GOV:

What income and household information do I provide when I apply for Marketplace coverage?

If you want to find out if you qualify for lower costs on Marketplace coverage, you’ll need to provide information about your household members and income.

The Marketplace application includes detailed instructions. It makes calculations using the information you provide to determine whether you’re eligible for lower costs.

The information on this page can help you prepare before you apply.

Reporting on your household

When filling out your application, DO include:

  • Yourself
  • Your spouse
  • Your children who live with you, even if they make enough money to file a tax return themselves
  • Your unmarried partner who needs health coverage
  • Anyone you include on your tax return as a dependent, even if they don’t live with you
  • Anyone else under 21 who you take care of and lives with you

DON’T include:

  • Your unmarried partner who doesn’t need health coverage and is not your dependent
  • Your unmarried partner’s children, if they are not your dependents
  • Your parents who live with you, but file their own tax return and are not your dependents
  • Other relatives who file their own tax return and are not your dependents

To learn about who qualifies as a dependent, refer to IRS Publication 501.

Estimating your income

When you apply for lower costs in the Marketplace, you’ll need to estimate your income for 2014.

You can start by adding up the following items for:

  • You and your spouse, if you are married and will file a joint tax return
  • Any dependents who make enough money to be required to file a tax return

For each of the following sources, estimate what your income will be in 2014:

  • Wages
  • Salaries
  • Tips
  • Net income from any self-employment or business (generally the amount of money you take in from your business minus your business expenses)
  • Unemployment compensation
  • Social Security payments, including disability payments–but not Supplemental Security Income (SSI)
  • Alimony

Other items to include when estimating your 2014 income are: retirement income, investment income, pension income, rental income, and other taxable income such as prizes, awards, and gambling winnings.

DON’T include the following:

  • Child support
  • Gifts
  • Supplemental Security Income (SSI)
  • Veterans’ disability payments
  • Workers’ compensation
  • Proceeds from loans (like student loans, home equity loans, or bank loans)

For more information on reporting your income, see IRS Publication 525.

Modified adjusted gross income and household income

When you fill out the Marketplace application, your estimated household income will be calculated using the information you provide. Your household income determines your eligibility for lower costs on Marketplace coverage.

Your household income is your modified adjusted gross income (MAGI) (joint MAGI if you’re married), plus the MAGI of your dependents who make enough money to have to file a tax return.

MAGI is generally your adjusted gross income plus any tax-exempt Social Security benefits (except for Supplemental Security Income (SSI), which is not counted), tax-exempt interest, and tax-exempt foreign income.

You don’t have to figure out your household income or MAGI yourself when you fill out your application. It will be done for you with the income information you include on the application.

FROM IRS PUBLICATION 525:

Scholarships and fellowships. A candidate for a degree can exclude amounts received as a qualified scholarship or fellowship. A qualified scholarship or fellowship is any amount you receive that is for:

  • Tuition and fees required to enroll at or at-tend an eligible educational institution, or
  • Course related expenses, such as fees, books, and equipment that are required for courses at the eligible educational institution. These items must be required of all students in your course of instruction. Amounts used for room and board do not qualify for the exclusion. See Publication 970 for more information on qualified scholarships and fellowship grants.

FROM IRS PUBLICATION 970:

Scholarships and Fellowships

A scholarship is generally an amount paid or allowed to, or for the benefit of, a student (whether an undergraduate or a graduate) at an educational institution to aid in the pursuit of his or her studies.

A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.

Amount of scholarship or fellowship. The amount of a scholarship or fellowship includes the following:

  • The value of contributed services and accommodations. This includes such services and accommodations as room (lodging), board (meals), laundry service, and similar services or accommodations that are received by an individual as a part of a scholarship or fellowship.
  • The amount of tuition, matriculation, and other fees that are paid or remitted to the student to aid the student in pursuing study or research.
  • Any amount received in the nature of a family allowance as a part of a scholarship or fellowship.

Tax-Free Scholarships and Fellowships

A scholarship or fellowship is tax free (excludable from gross income) only if you are a candidate for a degree at an eligible educational institution.

A scholarship or fellowship is tax free only to the extent:

  • It does not exceed your expenses;
  • It is not designated or earmarked for other purposes (such as room and board), and does not require (by its terms) that it cannot be used for qualified education expenses; and
  • It does not represent payment for teaching, research, or other services required as a condition for receiving the scholarship. (But for exceptions, see Payment for services, later.

Use Worksheet 1–1 to figure the amount of a scholarship or fellowship you can exclude from gross income.

Candidate for a degree. You are a candidate for a degree if you:

1. Attend a primary or secondary school or are pursuing a degree at a college or university, or
2. Attend an educational institution that:

  • Provides a program that is acceptable for full credit toward a bachelor’s or higher degree, or offers a program of training to prepare students for gainful employment in a recognized occupation; and
  • Is authorized under federal or state law to provide such a program and is accredited by a nationally recognized accreditation agency.

Eligible educational institution.  An eligible educational institution is one whose primary function is the presentation of formal instruction and that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.

Qualified education expenses. For purposes of tax-free scholarships and fellowships, these are expenses for:

  • Tuition and fees required to enroll at or attend an eligible educational institution, and
  • Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.

Expenses that do not qualify.Qualified education expenses do not include the cost of:

  • Room and board,
  • Travel,
  • Research,
  • Clerical help, or
  • Equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution.

Payment for services. Generally, you cannot exclude from your gross income the part of any scholarship or fellowship that represents payment for teaching, research, or other services required as a condition for receiving the scholarship. This applies even if all candidates for a degree must perform the services to receive the degree. (See below for exceptions.)

Exceptions. You do not have to treat as payment for services the part of any scholarship or fellowship that represents payment for teaching, research, or other services if you receive the amount under:

  • The National Health Service Corps Scholarship Program, or
  • The Armed Forces Health Professions Scholarship and Financial Assistance Program.

Example 1.

You received a scholarship of $2,500. The scholarship was not received under either of the exceptions mentioned above. As a condition for receiving the scholarship, you must serve as a part-time teaching assistant. Of the $2,500 scholarship, $1,000 represents payment for teaching. The provider of your scholarship gives you a Form W-2 showing $1,000 as income. Your qualified education expenses were at least $1,500. Assuming that all other conditions are met, $1,500 of your scholarship is tax free. The $1,000 you received for teaching is taxable.

Example 2.

You are a candidate for a degree at a medical school. You receive a scholarship (not under either of the exceptions mentioned above) for your medical education and training. The terms of your scholarship require you to perform future services. A substantial penalty applies if you do not comply. The entire amount of your grant is taxable as payment for services in the year it is received.

Athletic Scholarships

An athletic scholarship is tax free only if and to the extent it meets the requirements discussed later.

Worksheet 1-1. You can use Worksheet 1-1, Taxable Scholarship and Fellowship Income , later, to figure the tax-free and taxable parts of your athletic scholarship.

Taxable Scholarships and Fellowships

If and to the extent your scholarship or fellowship does not meet the requirements described earlier, it is taxable and must be included in gross income. You can use Worksheet 1–1, Taxable Scholarship and Fellowship Income, later, to figure the tax-free and taxable parts of your scholarship or fellowship.

Reporting Scholarships and Fellowships

Whether you must report your scholarship or fellowship depends on whether you must file a return and whether any part of your scholarship or fellowship is taxable.

If your only income is a completely tax-free scholarship or fellowship, you do not have to file a tax return and no reporting is necessary. If all or part of your scholarship or fellowship is taxable and you are required to file a tax return, report the taxable amount as explained below. You must report the taxable amount whether or not you received a Form W-2. If you receive an incorrect Form W-2, ask the payer for a corrected one.

For information on whether you must file a return, see Publication 501, Exemptions, Standard Deduction, and Filing Information, or your income tax form instructions.

How To Report

How you report any taxable scholarship or fellowship income depends on which return you file.

Form 1040EZ. If you file Form 1040EZ, include the taxable amount in the total on line 1. If the taxable amount was not reported on Form W-2, also enter “SCH” and the taxable amount in the space to the left of line 1.

Form 1040A. If you file Form 1040A, include the taxable amount in the total on line 7. If the taxable amount was not reported on Form W-2, also enter “SCH” and the taxable amount in the space to the left of line 7.

Form 1040. If you file Form 1040, include the taxable amount in the total on line 7. If the taxable amount was not reported on Form W-2, also enter “SCH” and the taxable amount on the dotted line next to line 7.

Schedule SE (Form 1040). To determine your net earnings from self-employment, include amounts you receive under a scholarship as pay for your services that are reported to you on Form 1099-MISC, Miscellaneous Income. If your net earnings are $400 or more, you must pay self-employment tax. Use Schedule SE, Self-Employment Tax, to figure this tax.

Form 1040NR. If you file Form 1040NR, report the taxable amount on line 12. Generally, you must report the amount shown in box 2 of Form(s) 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. See the Instructions for Form 1040NR for more information.

Form 1040NR-EZ. If you file Form 1040NR-EZ, report the taxable amount on line 5. Generally, you must report the amount shown in box 2 of Form(s) 1042-S. See the Instructions for Form 1040NR-EZ for more information.

Other Types of Educational Assistance

The following discussions deal with other common types of educational assistance.

Fulbright Grants

A Fulbright grant is generally treated as a scholarship or fellowship in figuring how much of the grant is tax free.

Pell Grants and Other Title IV Need-Based Education Grants

These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax free to the extent used for qualified education expenses during the period for which a grant is awarded.

Payment to Service Academy Cadets

An appointment to a United States military academy is not a scholarship or fellowship. Payment you receive as a cadet or midshipman at an armed services academy is pay for personal services and will be reported to you in box 1 of Form W-2. Include this pay in your income in the year you receive it unless one of the exceptions, discussed earlier under Payment for services , applies.

Veterans’ Benefits

Payments you receive for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free. Do not include these payments as income on your federal tax return.

If you qualify for one or more of the education benefits discussed in chapters 2 through 12, you may have to reduce the amount of education expenses qualifying for a specific benefit by part or all of your VA payments. This applies only to the part of your VA payments that is required to be used for education expenses.

You may want to visit the Veteran’s Administration website at www.gibill.va.gov for specific information about the various VA benefits for education.

Example.

You have returned to college and are receiving two education benefits under the latest GI Bill: (1) a $1,534 monthly basic housing allowance (BHA) that is directly deposited to your checking account, and (2) $3,840 paid directly to your college for tuition. Neither of these benefits is taxable and you do not report them on your tax return. You also want to claim an American opportunity credit on your return. You paid $5,000 in qualified education expenses (see chapter 2, American Opportunity Credit , later). To figure the amount of credit, you must first subtract the $3,840 from your qualified education expenses because this payment under the GI Bill was required to be used for education expenses. You do not subtract any amount of the BHA because it was paid to you and its use was not restricted.

Qualified Tuition Reduction

If you are allowed to study tuition free or for a reduced rate of tuition, you may not have to pay tax on this benefit. This is called a “tuition reduction.” You do not have to include a qualified tuition reduction in your income.

A tuition reduction is qualified only if you receive it from, and use it at, an eligible educational institution. You do not have to use the tuition reduction at the eligible educational institution from which you received it. In other words, if you work for an eligible educational institution and the institution arranges for you to take courses at another eligible educational institution without paying any tuition, you may not have to include the value of the free courses in your income.

The rules for determining if a tuition reduction is qualified, and therefore tax free, are different if the education provided is below the graduate level or is graduate education.

You must include in your income any tuition reduction you receive that is payment for your services.

Eligible educational institution. An eligible educational institution is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.

Officers, owners, and highly compensated employees. Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on substantially the same basis to each member of a group of employees. The group must be defined under a reasonable classification set up by the employer. The classification must not discriminate in favor of owners, officers, or highly compensated employees.

Payment for services. Generally, you must include in income the part of any qualified tuition reduction that represents payment for teaching, research, or other services by the student required as a condition of receiving the qualified tuition reduction. This applies even if all candidates for a degree must perform the services to receive the degree. (See below for exceptions.)

Exceptions. You do not have to include in income the part of any scholarship or fellowship that represents payment for teaching, research, or other services if you receive the amount under:

  • The National Health Service Corps Scholarship Program, or
  • The Armed Forces Health Professions Scholarship and Financial Assistance Program.

Education Below the Graduate Level

If you receive a tuition reduction for education below the graduate level (including primary, secondary, or high school), it is a qualified tuition reduction, and therefore tax free, only if your relationship to the educational institution providing the benefit is described below.

1. You are an employee of the eligible educational institution.
2. You were an employee of the eligible educational institution, but you retired or left on disability.
3. You are a widow or widower of an individual who died while an employee of the eligible educational institution or who retired or left on disability.
4. You are the dependent child or spouse of an individual described in (1) through (3), above.

Child of deceased parents. For purposes of the qualified tuition reduction, a child is a dependent child if the child is under age 25 and both parents have died.

Child of divorced parents. For purposes of the qualified tuition reduction, a dependent child of divorced parents is treated as the dependent of both parents.

Graduate Education

A tuition reduction you receive for graduate education is qualified, and therefore tax free, if both of the following requirements are met.

  • It is provided by an eligible educational institution.
  • You are a graduate student who performs teaching or research activities for the educational institution.

You must include in income any other tuition reductions for graduate education that you receive.

How To Report

Any tuition reduction that is taxable should be included as wages in box 1 of your Form W-2. Report the amount from Form W-2, box 1, on line 7 (Form 1040 or Form 1040A) or line 1 (Form 1040EZ).
 

THE TAKEAWAY

Here’s the thing. Most brokers aren’t CPAs and therefore shouldn’t be giving tax advice. Yes, it’s important to know what modified adjusted gross income is because it’s a key figure in determining eligibility for a premium tax credit. And the simple definition of modified adjusted gross income is what HHS told us: “MAGI is generally your adjusted gross income plus any tax-exempt Social Security benefits (except for Supplemental Security Income (SSI), which is not counted), tax-exempt interest, and tax-exempt foreign income.”

If someone asks a more detailed question than that, such as “do I need to include college financial aid?”, they’re not really asking about modified adjusted gross income for the premium tax credits. Whether they realize it or not (probably not), they’re actually asking how to calculate the adjusted gross income on their income taxes. So the short version of their question is “how do I do my taxes?” And for that, they should talk to their tax advisor.

Brokers – make that successful brokers – don’t have time to get in the weeds with each client and help them apply for a tax credit. Those who do are leaving money on the table because they’re probably not getting in front of enough prospects. A better option is to set up a private exchange site and divert individual leads to a call center that can answer these sorts of questions and help clients apply for a government subsidy. That will let you do what you do best – consult with employers, associations, and other organizations that have a lot individuals and families who might qualify for financial assistance and help them deliver a solution that will help both the organization and its employees or individual members.

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