With college tuition coming due, families should consider tax efficient ways to pay for these expenses. Grandparents who wish to help their children with tuition costs can take advantage of some special gift tax breaks.
Grandparents have the usual annual present interest gift tax exclusion (now $14,000) and a lifetime exclusion (now $5,340,000). When a spouse joins in the gift (the called “spousal joinder”), these amounts double .
But these are not the only tax breaks available to a grandparent who wants to help the family. In addition, grandparents have an unlimited gift tax exemption for amounts paid for tuition. By using this special educational exclusion, such payments do not count against the annual gift tax or lifetime exclusions.
Here are the basic rules to qualifying these gifts for such unlimited educational exemption:
Unlimited Exclusion For Tuition Only
This exclusion from the gift tax for gifts of tuition is unlimited in amount. However, the scope of the exclusion applies to tuition only.
Books, Supplies and Other Items Not Covered
There is no exclusion for amounts paid for the following:
- Board or other similar expenses that are not direct tuition costs.
- Laboratory fees
- Dormitory fees
See Treasury Regulations 25.2503-6(b)(2) for more details.
While Only Tuition Qualifies, This Educational Exemption Can Be For Part-Time or Full-Time Tuition
The gift tax is not imposed on amounts paid as tuition for a student to a qualifying domestic or foreign educational organization for the education or training of such person. See Code Section 2503(e)(1) and (2)(A).
Tuition payments for the student qualify where enrollment is part-time or full-time.
Qualifying Educational Organization
A qualifying educational organization is one which:
- Normally maintains a regular faculty and curriculum and
- Normally has a regularly enrolled body of students in attendance at the place where its educational activities are regularly carried on.
See Code Section 170(b)(1)(A)(ii) and Treasury Regulation 25.2503-6(b)(2).
Direct Payment of Tuition to Educational Organization
The tuition payment must be made directly to the educational organization to qualify for this exclusion.
Neither a payment to the student for delivery to the organization nor a payment to a trust for the student’s benefit for delivery to the educational organization will qualify for this exclusion. See Treasury Regulation 25.2503-6(b)(2) and (c) (Example 1).
Advance payments for future school years, made directly to a private school and used exclusively for the tuition expenses of designated students were excludable gifts where the payments were nonrefundable and the school would keep the funds if the children ceased to attend the school. TAM 199941013, PLR 200602002.
Prepayment of many years of private school tuition for a young child occurred in both cases. Since anything can happen with young children care should be exercised before making such a large prepayment.
No Special Relationship Required between Donor and Donee
This educational exclusion is permitted without regard to the relationship between the donor (person making the gift) and the donee (recipient of the gift).
Recipients (donees) need not be a dependent of the donor or even related to the donor.
No Impact on Annual Present Interest Gift and the Lifetime Gift Tax Exemption:
This exclusion does not use up the following other gift tax exclusions available to the donor:
1. Annual present interest gift tax exclusion of $14,000, and
2. Lifetime gift tax exclusion of $5,340,000
Gift Tax Return
No gift tax return (Form 709) needs filing where the only gift during the tax year qualifies for the tuition gift tax exemption.
Section 529 Plans – Special Rules
Contributions to a Qualified State Tuition Program (a Section 529 plan) do not qualify for this educational expense exemption. See Code Section 529(c)(2)(A)(ii).
But a contribution to a Section 529 plan qualifies as a completed gift of a present interest that is eligible for the gift tax annual exclusion of $14,000. If the spouse joins in the gift the exclusion would be $28,000. For more on this topic please read Section 529 Plans: Gift Tax Rules.
This exclusion offers a very powerful tool for overall estate and tax planning for families. Donors should consider it as part of a family’s overall estate and gift tax strategies. Although not discussed, state inheritance taxes should be considered as part of this tax saving strategy.
Sit down with your experienced and skilled estate planning attorney or reach out to us before doing anything to make sure this planning tool is right for your specific situation and your overall estate plan.
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