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 in the future – even though the donor isn’t alive once the tuition money is really 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 are gift-tax free are tuition costs. The expense of room and board, books, and other educational expenses are not exempt.
Second, the tuition costs must be paid right to an academic organization that “normally maintains a typical faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.” Notice that there surely 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 might also qualify. It’s possible, too, that tuition payments for part-time courses, such as dance, theater, music, cullinary arts, and the like will also qualify for the gift tax exemption.
So, how is this such much? In the very first place, these tuition payments are not treated as taxable gifts, so you don’t need certainly to worry about having them come underneath the annual gift tax exclusion. In fact, you can make tuition payments for the 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 large enough to stress about federal estate taxes (currently in excess of $2 million, $4 million for a couple), then the total amount of the english and maths tutor online tuition payments is likely to be excluded from your own estate upon your death. Quite simply, your tuition payments won’t be susceptible to a gift tax once the payments are created, nor will they be susceptible to an estate tax upon your death. Additionally, they’ll not be susceptible to any generation-skipping taxes (GST) upon your death
That’s very good deal alone, 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 specific case, some grandparents had made payments to a personal school to cover tuitiion costs for their two grandchildren from pre-school through grade 12. There is an agreement between the school and the grandparents indicating that the tuition payments would not be refundable even though the grandchildren failed to attend the school each of those years. The total payments made 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 several years of tuition costs for his grandchildren would not be considered a gift.
While Technical Advice Memorandums and private letter rulings only apply to the taxpayer’s who request them, they are a great indication of the IRS’ position on specific tax matters. Here, it seems fairly clear that prepayment of multiple years of tuition costs won’t 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 weren’t treated as taxable gifts and, since the amount of money was taken from their estate, it was not susceptible to estate taxes upon their death. If the grandparents kept the amount of money until they died and then gave it to their grandchildren under their will, it could have been through probate first, then would have been susceptible to a federal estate tax and then, possibly, a generation-skipping tax – all before it could be employed by the grandchildren.
If the grandparents had a fairly large estate, say bigger than $4 million, then the estate taxes paid on that $181,000 would be roughly $83,260 (based upon a limited tax rate of 46%). In that case, prepaying the tuition costs resulted in an 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.