With education costs soaring to any or all time highs, making tuition payments for grandchildren and others can save plenty of cash in gift and estate taxes later on – even when the donor is not alive when the tuition money is obviously 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 only educational costs that are gift-tax free are tuition costs. The cost of room and board, books, and other educational expenses aren’t exempt.
Second, the tuition costs should 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 where its educational activities are regularly carried on.” Notice that there’s no requirement that the tuition costs be paid to a college or university. Actually, tuition payments for nursery school, private elementary school, and private high school can also qualify. It’s possible, too, that tuition payments for part-time courses, such as for instance dance, theater, music, cullinary arts, and such will also qualify for the gift tax exemption.
So, how is this such a great deal? In the very first place, these tuition payments aren’t treated as taxable gifts, which means you don’t have to be concerned about having them come underneath the annual gift tax exclusion. Actually, you may make tuition payments for your grandchildren or others and still give all 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 total amount of the tuition payments will undoubtedly be excluded from your estate upon your death. In other words, learn maths and english online your tuition payments will not be susceptible to something special tax when the payments are manufactured, nor will they be susceptible to an estate tax upon your death. In addition, they’ll not be susceptible to any generation-skipping taxes (GST) upon your death
That’s pretty good deal by itself, 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 particular case, a couple of grandparents had made payments to an exclusive school to cover tuitiion costs for their two grandchildren from pre-school through grade 12. There clearly was an agreement between the school and the grandparents indicating that the tuition payments wouldn’t be refundable even when the grandchildren failed to go to the school each of these years. The total payments created by the grandparents amounted to over $181,000 over a two-year period.
Recently, the Internal Revenue Service issued an exclusive 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 certainly be a gift.
While Technical Advice Memorandums and private letter rulings only connect with the taxpayer’s who request them, they are an excellent 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 type 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 from their estate, it was not susceptible to estate taxes upon their death. If the grandparents kept the cash until they died and then gave it to their grandchildren under their will, it would have gone through probate first, then could have been susceptible to a federal estate tax and then, possibly, a generation-skipping tax – all before maybe it’s used by the grandchildren.
If the grandparents had a fairly large estate, say bigger than $4 million, then a estate taxes paid on that $181,000 could be roughly $83,260 (based upon a little 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.