A Gifting "Gotcha" —
Gifting and Qualified Tuition Plans
By: Patricia T. Henssler, C.P.A.
The Henssler Financial Group Position Paper

The Hensler Financial Group Wealth ManagementTuition payments to a qualified educational institution are exempt from the gift tax rules (as are medical payments made to the medical provider). This means that you, a grandparent, or anyone, can gift a child $12,000 (2008 amount, indexed) and pay their college tuition to Harvard (you are required to make the check out to the institution).

We are now getting a lot of good questions regarding gifts in conjunction with 529 Plans and the Education Savings Account. Unfortunately, this is in black and white in the IRS Code. The IRS Code specifically states that contributions to a qualified tuition program or Education Savings Account are gifts.

"After August 5, 1997, any contribution to a qualified tuition program, whether sponsored by a state or a private education institution, on behalf of a designated beneficiary is a completed gift of a present interest eligible for the annual exclusion at the time the contribution is made.1 Similar treatment is accorded to any contribution to a Education Savings Account (formerly known as an education IRA) after 1997.2 Neither gift is treated as a qualified transfer eligible for the educational gift tax exclusion.3 If a donor's contribution, made after August 5, 1997, exceeds the annual gift-tax exclusion amount, ($12,000 in 2008), the donor may elect to take the excess into account ratably over five years.4 Thus, an individual may contribute up to $60,000 per child in one year tax free of gift tax due to the allowance of the five-year spread of the annual gift tax exclusion."

This may take careful planning, or careful "remembering" in the future regarding gifts to your children, grandchildren, etc.

Example 1
Contribute $60,000 this year to a qualified tuition program for your child.

Choice 1 - Claim $12,000 as part of the annual gift exclusion and pay gift tax or use part of your lifetime exemption for the $48,000 balance.

Choice 2 - Elect to treat the $60,000 over a five year period. You would use $12,000 per year for five years.

The Code does allow you to make additional gifts in future years, exempt from gift tax, if the annual allowance increases. Therefore, if it were to increase to $13,000 next year, you could gift your child $1,000 next year and be exempt from gift tax.

Example 2
Contribute $15,000 this year to a qualified tuition program for your child.

Choice 1 - Claim $12,000 as part of the annual gift exclusion and pay gift tax or use part of your lifetime exemption for the $3,000 balance.

Choice 2 - Elect to treat the $15,000 over a five year period. You would use $3,000 per year for five years. You would then be able to make additional cash gifts to your children, up to the annual exclusion, each year for the five years.

Planning Opportunity

According to IRS Technical Advice Memorandum 199941013, July 9, 1999, prepaid tuition qualifies for the gift tax exclusion.

A grandmother's payments to a school for her two grandchildren's tuition qualified for the unlimited gift tax exclusion for qualifying tuition payments. The grandmother paid tuition for the current year and nine subsequent years to the school her grandchildren were currently attending. The payments, which were specifically designated as for her grandchildren's benefit, were not refundable if the children ceased attending the school. Any shortfall due to increases in tuition in future years would be covered by payments from the children's father.

Since the payments qualified as gifts (although not part of the annual exclusion), they were not includable in the grandmother's taxable estate. A grandparent wishing to maximize annual excludable gifts in order to minimize the size of the grandparents' taxable estate can use prepaid tuition plans as an estate planning tool. These payments must be made directly to the school in order to qualify for the exclusion. If you would like further information regarding this topic or any other tax related issue, please contact The Henssler Financial Group Tax & Accounting Division at 770-428-4025.

1 Code Sec. 529 (c)(2)
2 Code Sec. 530(d)(3)
3 Code Sec. 529(c)(2)(A)(ii), 530(d)(3), 2503(e)
4 Code Sec. 529(c)(2)(B)
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