With education costs soaring to all or any time highs, making tuition payments for grandchildren and others can save lots of money 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 sole educational costs that 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 must certanly be paid straight to an academic organization that “normally maintains a regular 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 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 high school may also qualify. It’s possible, too, that tuition payments for part-time courses, such as for instance dance, theater, music, cullinary arts, and the like will even qualify for the gift tax exemption.
So, how is this such much? In the first place, these tuition payments are not treated as taxable gifts, so you don’t need certainly to worry about having them come under the annual gift tax exclusion. In fact, you can 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 large enough to be concerned 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 own estate upon your death. In other words, your tuition payments will not be subject to something special tax when the payments are manufactured, nor will they be subject to an estate tax upon your death. Furthermore, 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 english and maths tutor online stating that prepayment of tuition costs was also exempt from gift taxes under IRC Section 2503(3)(2). In that particular case, a set of grandparents had made payments to a private school to cover tuitiion costs for their two grandchildren from pre-school through grade 12. There clearly was an agreement between the institution and the grandparents indicating that the tuition payments wouldn’t be refundable even when the grandchildren failed to attend the institution each of these years. The sum 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 numerous years of tuition costs for his grandchildren wouldn’t certainly be a gift.
While Technical Advice Memorandums and private letter rulings only affect 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 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 cash was taken from 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 would have experienced probate first, then could have been subject to a federal estate tax and then, possibly, a generation-skipping tax – all before it could be used by the grandchildren.
If the grandparents had a reasonably large estate, say larger than $4 million, then your estate taxes paid on that $181,000 will be roughly $83,260 (based upon a minimal 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 have the estate tax savings.