With education costs soaring to all time highs, making tuition payments for grandchildren and others can save lots of money in gift and estate taxes down the road – even though the donor is not alive once the tuition money is actually used.
Through some background, the tax laws exempt tuition payments by grandparents or others from any gift taxes, provided certain requirements are met. First, the sole educational costs which are gift-tax free are tuition costs. The price of room and board, books, and other educational expenses are not exempt.
Second, the tuition costs should be paid right to an educational organization that “normally maintains a typical faculty and curriculum and normally includes a regularly enrolled body of pupils or students in attendance at where its educational activities are regularly carried on. tuition for maths ” Notice that there’s no requirement that the tuition costs be paid to a college or university. In fact, tuition payments for nursery school, private elementary school, and private senior school may also qualify. It’s possible, too, that tuition payments for part-time courses, such as for example dance, theater, music, cullinary arts, and the like will even qualify for the gift tax exemption.
So, how is this such a good deal? In the very first place, these tuition payments are not treated as taxable gifts, which means you don’t need certainly to bother about having them come underneath the annual gift tax exclusion. In fact, you may make tuition payments for the grandchildren or others and still give each of them the annual exclusion amount ($12,000 for 2006) as a birthday gift or whatever.
Second, if your estate is large enough to take into account federal estate taxes (currently in excess of $2 million, $4 million for a couple), then the total amount of the tuition payments will undoubtedly be excluded from your estate upon your death. Put simply, your tuition payments will not be subject to a gift tax once the payments are manufactured, nor will they be subject to an estate tax upon your death. In addition, they will not be subject to any generation-skipping taxes (GST) upon your death
That’s decent deal by itself, but here’s an extra bonus. On July 9, 1999, the Internal Revenue Service issued Technical Advice Memorandum 199941013 stating that prepayment of tuition costs was also exempt from gift taxes under IRC Section 2503(3)(2). In that one case, a set of grandparents had made payments to a personal school to cover tuitiion costs because of their two grandchildren from pre-school through grade 12. There clearly was an agreement between the college and the grandparents indicating that the tuition payments wouldn’t be refundable even though the grandchildren failed to wait the college each of these years. The sum total payments produced by the grandparents amounted to over $181,000 over a two-year period.
Recently, the Internal Revenue Service issued a personal letter ruling that supports the Technical Advice Memorandum cited above. In that case, the IRS told a taxpayer that prepayments of numerous years of tuition costs for his grandchildren wouldn’t be described as a gift.
While Technical Advice Memorandums and private letter rulings only affect the taxpayer’s who request them, they’re a great indication of the IRS’ position on specific tax matters. Here, it appears fairly clear that prepayment of multiple years of tuition costs will not be treated as a taxable gift by the IRS.
Now, let’s kind of put all of this into perspective. In the TAM discussed above, the grandparents pre-paid roughly $181,000 of tuition costs over a two-year period. The payments were not treated as taxable gifts and, since the cash was taken off their estate, it was not subject to estate taxes upon their death. If the grandparents kept the cash until they died and then gave it with their grandchildren under their will, it might have gone through probate first, then would have been subject to a federal estate tax and then, possibly, a generation-skipping tax – all before maybe it’s employed by the grandchildren.
If the grandparents had a reasonably large estate, say larger than $4 million, then the estate taxes paid on that $181,000 would be roughly $83,260 (based upon a minor tax rate of 46%). In that case, prepaying the tuition costs resulted within an estate tax savings of roughly $83,260. Plus, the grandparents didn’t have to use up their annual gift-tax exclusion to get the estate tax savings.