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 in the future – even if the donor isn’t alive when the tuition money is in fact used.
By way 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 price 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 includes a regularly online maths and english tuition 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 reality, 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 dance, theater, music, cullinary arts, and such will even qualify for the gift tax exemption.
So, how is this such a great deal? In the initial place, these tuition payments are not treated as taxable gifts, so you don’t need certainly to be concerned about having them come beneath the annual gift tax exclusion. In reality, you can make tuition payments for your 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 be concerned about federal estate taxes (currently in excess of $2 million, $4 million for a couple), then the quantity of the tuition payments will soon be excluded from your own estate upon your death. Put simply, your tuition payments will not be subject to a present tax when the payments are made, nor will they be subject to an estate tax upon your death. Additionally, they will not be subject to any generation-skipping taxes (GST) upon your death
That’s pretty good deal on it’s own, but here’s an additional 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 particular case, some grandparents had made payments to a private school to cover tuitiion costs for their two grandchildren from pre-school through grade 12. There is an agreement between the college and the grandparents indicating that the tuition payments wouldn’t be refundable even if the grandchildren failed to wait the college each of these years. The full total payments created 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. In that case, the IRS told a taxpayer that prepayments of several years of tuition costs for his grandchildren wouldn’t be considered a gift.
While Technical Advice Memorandums and private letter rulings only connect with the taxpayer’s who request them, they’re a great indication of the IRS’ position on specific tax matters. Here, it seems fairly clear that prepayment of multiple years of tuition costs will not be treated as a taxable gift by the IRS.
Now, let’s sort 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 were not treated as taxable gifts and, since the amount of money was taken off their estate, it was not subject to estate taxes upon their death. If the grandparents kept the amount of money until they died and then gave it with their grandchildren under their will, it would have experienced probate first, then would have been subject to a federal estate tax and then, possibly, a generation-skipping tax – all before maybe it’s utilized by the grandchildren.
If the grandparents had a fairly large estate, say larger than $4 million, then a 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 utilize up their annual gift-tax exclusion to get the estate tax savings.