What Must a School Do When a Contributor Reports a Foreign Earned Income Exclusion?

Award Year: 2024-25 KA-36595 Helpfulness Rating 8,324 page views

This guidance is specific to the 2024-25 award year and later.

Effective with the 2024-25 award year, the Foreign Earned Income Exclusion reported on the 1040 tax return Schedule 1 is no longer excluded from need analysis. Therefore, the exclusion amount must be reported as untaxed income on the FAFSA under Section 480(b)(5) the Higher Education Act of 1965 (HEA), as amended, [20 USC 1087vv(b)], which refers to the income exclusion as "foreign income exempt from federal taxation."

First, if the student/parent is selected for verification and reported an amount for the Foreign Earned Income Exclusion, you must complete verification. See AskRegs Knowledgebase Q&A, Do We Only Verify the Foreign Earned Income Exclusion If an Amount Is Reported On the FAFSA?

Then, you make the following determination and adjustment, as applicable. The guidance in Dear Colleague Letter GEN-23-11 and SAI-Q6/A6 in the U.S. Department of Education's (ED's) FAFSA Simplification Questions and Answers shares that the Foreign Earned Income Exclusion amount will not be transferred to the FAFSA via the FUTURE Act Direct Data Exchange (FA-DDX) and will, rather, require manual entry by the applicant or contributor (student, parents, stepparents, and students’ spouses). The Foreign Earned Income Exclusion amount will be included in the student aid index (SAI) calculation, meaning the exclusion amount will be added to adjusted gross income (AGI) along with other untaxed income items, such as tax-exempt interest income, to arrive at the Total Income figure used in the SAI calculation. However, the exclusion amount will not be considered in the automatic maximum Federal Pell Grant eligibility determination, which relies on AGI, not Total Income. Instead, a new C Flag and Comment Codes 040, 076, 096, and/or 127 (depending on the contributor) will appear on the Institutional Student Information Record (ISIR) when an ISIR contains both a Maximum Pell Indicator flag (meaning the student is eligible for the maximum Pell Grant) and a valid value in the “Foreign Earned Income Exclusion” data field.

By not including the Foreign Earned Income Exclusion amount in the automatic maximum Pell Grant eligibility determination, some students could receive an automatic maximum Pell Grant award despite having significant amounts of untaxed income. Because of this, ED is establishing a process by which financial aid administrators (FAAs) would have to determine for students with this C Flag if adding the exempted foreign income to the AGI would make the student ineligible to receive the automatic maximum Pell Grant award. If that would occur, the FAA must then determine whether it is appropriate to use professional judgment (PJ) to increase the AGI by the amount of the exempted foreign income to determine the student’s eligibility for the automatic maximum Pell Grant (in which case the student would now be ineligible for the automatic maximum Pell Grant.) If the FAA decides that it is appropriate, the FAA may move the foreign earned income amount from untaxed income to AGI. ED also offers that FAAs may request additional documentation of the foreign income prior to performing a PJ adjustment to AGI and automatic maximum Pell Grant eligibility.

In short, according to SAI-Q6/A6, the FAA must perform the review and may decide if it is appropriate to make the adjustment. The Q&A further states, " If the FAA decides that it is appropriate, the FAA may move the foreign earned income amount from untaxed income to AGI or request additional documentation of the foreign income prior to performing the adjustment."

As an example, the married parents of a dependent student living in Maryland with a family size of 3 have an AGI of $10,000 and a Foreign Earned Income Exclusion of $70,000. The student qualifies for an automatic maximum Pell Grant because their parents’ AGI of $10,000 falls below 175% of the federal poverty guidelines (2022 FPG for a family of 3 = 23,030; 175% = 40,303). If the income exclusion were removed from untaxed income and added to AGI, however, the AGI would be $80,000, which exceeds 175% of the federal poverty guideline, and the student would no longer qualify for the automatic maximum Pell Grant award. Note that the student’s SAI would also likely change even though their Total Income does not change, because they would be assigned an SAI of 0 if they received the automatic maximum Pell Grant. On the other hand, if their AGI were increased by the amount of the income exclusion and they no longer qualified for the automatic maximum Pell Grant and associated 0 SAI, they would instead have an SAI calculated based on an AGI of $80,000.

Remember: The above process is only for automatic maximum Pell recipients with a Foreign Earned Income Exclusion--not all Pell recipients.

Note: This is a statutory requirement under Section 401(b)(1)(D) of the Higher Education Act of 1965 (HEA), as amended [20 USC 1070A(b)(1)(D) Amendment of Section].

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