With education costs soaring to all or any time highs, making tuition payments for grandchildren and others can save a lot of money in gift and estate taxes later on – even when the donor is not alive when the tuition money is actually used.
By means of 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 can be gift-tax free are tuition costs. The cost of room and board, books, and other educational expenses are not exempt.
Second, the tuition costs must be paid straight to an academic organization that “normally maintains a typical faculty and curriculum and normally features a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” Notice that there is 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 can also qualify. It’s possible, too, that tuition payments for part-time courses, such as for example dance, theater, music, cullinary arts, and such will also qualify for the gift tax exemption.
So, how is this such a good deal? In the initial place, these tuition payments are not treated as taxable gifts, which means you don’t need to concern yourself with 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 big enough to bother about federal estate taxes (currently in excess of $2 million, $4 million for a couple), then the amount of the tuition payments will undoubtedly be excluded from your estate upon your death. In other words, your tuition payments won’t be subject to a gift tax when the payments are made, 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 alone, but here’s an added 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 specific case, a couple of grandparents had made payments to a private school to cover tuitiion costs for their two grandchildren from pre-school through grade 12. online maths and english tuition There is an agreement between the school and the grandparents indicating that the tuition payments would not be refundable even when the grandchildren failed to go to the school each of those years. The full total payments made by the grandparents amounted to over $181,000 over a two-year period.
Recently, the Internal Revenue Service issued a private letter ruling that supports the Technical Advice Memorandum cited above. For the reason that case, the IRS told a taxpayer that prepayments of several years of tuition costs for his grandchildren would not be described as a gift.
While Technical Advice Memorandums and private letter rulings only apply to the taxpayer’s who request them, they are a good indication of the IRS’ position on specific tax matters. Here, it appears fairly clear that prepayment of multiple years of tuition costs won’t be treated as a taxable gift by the IRS.
Now, let’s type of put all 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 weren’t treated as taxable gifts and, since the money was taken from their estate, it wasn’t subject to estate taxes upon their death. If the grandparents kept the money until they died and then gave it for their grandchildren under their will, it could have gone through probate first, then could have been subject to a federal estate tax and then, possibly, a generation-skipping tax – all before it could be utilized by the grandchildren.
If the grandparents had a reasonably large estate, say larger than $4 million, then a estate taxes paid on that $181,000 would be roughly $83,260 (based upon a marginal tax rate of 46%). For the reason that case, prepaying the tuition costs resulted in a estate tax savings of roughly $83,260. Plus, the grandparents didn’t have to utilize up their annual gift-tax exclusion to obtain the estate tax savings.