Do you have older clients with grandchildren who are in college or plan to attend in the near future? Undoubtedly, the grandparents are sympathetic to the plight of the cash-strapped parents who must pay ever-escalating costs to put their kids through school. Some may have even volunteered to establish a 529 plan, a trust or custodial account, or some other education-planning device to help defray the costs.
But other clients don't want to make any long-term commitments or prefer the freedom of doling out cash whenever they pick and choose. Of course, they expect to realize the optimal tax benefits without incurring any extra tax liabilities. For these taxpayers, there's a âright wayâ and a âwrong wayâ to hand out gifts to be used for higher education.
First, here's the wrong way: The grandparent gives the money to an adult child who, in turn, uses the money to pay the school. In this case, the adult child is the one who qualifies for the education tax breaks on a federal income tax return, such as the American Opportunity Tax Credit (AOTC), subject to the usual limitations.
In addition, the gift is subject to the federal gift tax that is assessed to donors. Although an annual gift tax exclusion of $14,000 per recipient applies for gifts in 2015, this threshold can easily be exceeded for a grandchild attending an elite university. Amounts above the $14,000 threshold can erode the grandparent's unified estate and gift tax credit.
Now here's the right way: The grandparent pays higher education expenses like tuition directly to the school. In other words, you âcut out the middleman.â As the payer, the grandparent may qualify for the AOTC or other tax benefits, again subject to the restrictions in the tax law.
What's more, this technique also qualifies for a unique gift tax break. If you pay the college directly, the limit on annual gifts doesn't apply. In other words, you can give gifts above the $14,000 per recipient threshold â in fact, it can be for any amount â without using up one penny of the gift exclusion or the unified estate and gift tax credit.
A similar tax break is available if you pay medical expenses of a relative. If you pay the healthcare provider directly instead of giving the relative the cash, the federal gift tax limits don't come into play.
Figure out the best approach for your clients. If they are inclined to simply give away cash to help pay for college, make sure they do things the right way.
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...