Tax-Smart Strategies for Higher-Income Families Navigating Financial Aid

With many families preparing for first-time and returning students to begin college in the fall, understanding the tax implications of financial aid is more important than ever—especially for higher-income families who may not qualify for need-based assistance. As tuition costs continue to rise, and without access to traditional forms of aid, thoughtful tax planning becomes a critical part of managing education expenses.

Tax Implications of Financial Aid

For higher-income families, paying for college usually means bearing the full cost of tuition, room and board, and related expenses without the benefit of need-based aid. And while scholarships and grants can provide some relief, these families often face unique tax considerations—especially when it comes to maximizing what limited tax benefits remain accessible.

Scholarships, Grants, and Taxable Income: Even for families who don’t qualify for need-based assistance, merit-based scholarships and grants are sometimes available. It’s important to understand that the tax treatment of these funds depends on how they’re used. When applied toward qualified education expenses—like tuition, fees, and required course materials—scholarships are generally tax-free. However, any portion used for non-qualified expenses, such as room and board or transportation, may be taxable to the student. Given the narrow margin of relief for high-income families, it’s essential to track how funds are allocated and consult a tax advisor to avoid unanticipated income tax liability.

Tax Credits for Education: Many higher-income families find themselves phased out of popular tax benefits, such as the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC), both of which have strict income limits. For 2024, the AOTC begins to phase out for joint filers earning above $160,000 and is completely unavailable for those earning above $180,000. However, through strategic planning—such as shifting certain expenses to the student’s return—families may still find ways to leverage these credits. Understanding what expenses qualify, how scholarships affect credit eligibility, and who can claim the credit can make a significant difference in reducing the overall tax burden.

Targeted Tax Planning for High-Income Families

While traditional need-based aid may be out of reach for high-income households, there are still meaningful ways to reduce the cost of education through thoughtful tax planning. From leveraging business structures to strategically shifting income or assets, families can explore alternative avenues that ease the financial impact of college without relying on financial aid formulas. The key is identifying which opportunities align with your family’s income profile and long-term goals.

Employing Children in the Family Business: If you own a business, consider employing your child in a legitimate capacity. Wages paid to the child for real work performed are deductible to the business and shift income to the child’s lower tax bracket. If the student uses their earnings to pay for qualified education expenses, they may be able to claim the AOTC on their tax return—something their parents likely can’t do due to income limits. This approach can lower the family’s overall tax burden while also encouraging the student to take financial ownership of their education.

Gifting Appreciated Stock for Education Costs: Gifting appreciated securities to a child—who then liquidates the assets to help fund their education—can reduce overall capital gains tax exposure. If the child provides over half of their own support, they may also qualify for education credits. This approach offers flexibility by both lowering taxable income at the parent level and enabling the student to benefit from otherwise unavailable education incentives.

When It Pays to Include Scholarships as Income: While most families aim to exclude scholarship income from taxation, there are times when including a portion of the scholarship as taxable income is advantageous. By making part of the scholarship taxable—particularly the portion covering non-qualified expenses, such as room and board—families may unlock education tax credits that would otherwise be disallowed due to double-dipping rules. Keep in mind that this is a nuanced strategy, making it crucial to consult with a tax advisor to ensure it is implemented correctly and aligns with your overall financial plan.

The Role of 529 Plans

While 529 college savings plans are commonly associated with financial aid planning, they also offer significant tax advantages for high-income families—regardless of aid eligibility. Qualified withdrawals are tax-free, and many states offer deductions or credits for contributions. Even for families unlikely to receive need-based aid, 529 plans can be a powerful tool to grow savings tax-efficiently and fund future college expenses. Thoughtful timing of withdrawals and coordination with other tax strategies—like maximizing education credits where eligible—can enhance the overall value of these accounts.

Adjusting for Special Circumstances

While financial aid appeals are often associated with sudden changes in income or family structure, they typically have a limited impact on high-income households that remain above the FAFSA thresholds even after adjustments. However, it’s still worth understanding how schools handle financial aid exceptions—especially for families navigating divorce settlements, one-time income events (like stock sales), or large medical expenses. In select cases, private institutions using the CSS Profile may consider more nuanced financial information beyond the FAFSA. High-income families should work closely with advisors and financial aid offices to explore whether any exceptions apply—and, more importantly, plan proactively to avoid disqualifying situations before submitting aid applications.

Preparing for Repayment

Even if your family isn’t relying heavily on student loans for undergraduate education, repayment planning still plays an important role—especially when it comes to graduate programs, parent PLUS loans, or situations where your child is responsible for their own debt after graduation. With interest rates and repayment options constantly evolving, staying ahead of policy changes can help you avoid unnecessary costs. In some cases, early repayment or refinancing could provide meaningful long-term savings. Partnering with a financial advisor can ensure that repayment strategies align with broader wealth planning and help students establish a solid foundation for their financial futures.

Seek Guidance on Financial Aid and Tax Matters

Covering the cost of college is just one piece of the puzzle. For families with more complex financial profiles, thoughtful tax planning can unlock meaningful savings. Since no two families are alike, your strategy should reflect your unique circumstances, income level, and long-term financial goals. Contact your CRI advisor to explore personalized planning opportunities that align with your broader financial picture and help you get the most value from your education investment.