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COLLEGE SAVINGS 101

Santa's Gift (tax) List

Posted 2011-12-21

by Joseph Hurley

It is rumored that Santa Claus makes billions of gifts every year to children around the world, worth tens of billions of dollars. Yet even if Santa were a resident of the United States, he probably would not be obligated to file gift-tax forms, since he generally keeps any one child's Christmas bounty below the $13,000 gift-tax annual exclusion amount.

Your clients should be so fortunate. When they look at the price of a college degree, and decide to save towards that future expense, gift-tax issues can loom large. And don't let your clients believe the IRS won't ever check on their gift-giving; a recent article points out the lengths they are going to in "catching" parents who, for example, give their children the deeds to their homes.

With all that in mind, here are some year-end gift-tax tips for your clients when using 529 plans to save for college.

Take advantage of the $13,000 annual exclusion.
You can contribute as much as $13,000 this year to a 529 plan for your child or grandchild -- or anyone else for that matter -- without triggering a gift-tax filing requirement. Grandparents especially, when looking to make estate-planning moves, will find 529 plans to be an attractive alternative to Uniform Transfers to Minors Act gifts and U.S. saving bonds. Although the money comes out of your estate, it does not leave your control, and you can even refund the account if you ever decide you want the money returned to you. (Refunded earnings are subject to federal tax and 10% tax penalty.)

Take advantage of the five-year election.
The five-year election is unique to 529 plans. It allows you to make a contribution of more than $13,000, and up to as much as $65,000, without creating a "taxable" gift, because your contribution this year is treated for gift-tax purposes only as being made in five equal annual installments. Of course, each installment is eligible for the annual exclusion, which is $13,000 for 2011 and 2012, but will eventually increase to $14,000. If you have $78,000 to put into the 529 plan, hold off on the $65,000 contribution until next month (January 2012) and contribute only $13,000 this year. You must file Form 709, the gift-tax return, to elect five-year treatment even when the effect of the election is to keep you below the $13,000 annual exclusion amount.

Keep track of other gifts made during the year.
Your contribution to a 529 plan is only one type of gift. Other gifts you make during the year, like cash and securities, reduce the available annual exclusion for your 529 contributions, and also impact the amount that can be contributed gift-tax-free with the five-year election. Remember, too, that while Upromise and other purchase rewards programs can be a great way to increase your college savings, the rebates that go into your child's 529 account are also considered gifts subject to the annual exclusion.

Agree to split gifts between spouses.
If you are married, the annual exclusion amount doubles to $26,000, and the five-year election cap becomes $130,000. If you and your spouse consent on Form 709 to split your gifts, it doesn't matter who actually makes the contributions to your 529 plan. You may find it easier to keep your 529 accounts under one parent's ownership, although be sure to consider certain risks where ownership may have an impact, like creditor lawsuits and marriage dissolution. Also, be sure to look at the rules in your state regarding a state income tax deduction or credit for your contributions to a 529 plan: some states set a lower cap on the amount of your deduction if only one spouse has a 529 account.

Keep separate 529 accounts for the children.
If you have two or more children, you may be thinking that it would be easier, and perhaps cheaper (if the 529 plan charges an account maintenance fee), to open a 529 account for just one child, with the intention of moving funds around in the future to pay for the other children's college expenses. This strategy is certainly possible by making timely changes in beneficiary or fund transfers to sibling 529 accounts as needed. But for most families, setting up separate 529 accounts for the children makes more sense. You'll have multiple gift-tax annual exclusions to work with, instead of just one $13,000 amount, not to mention better family bookkeeping and more appropriate age-based investment options.

Set up a 529 account for yourself.
Let's say you've run through your $13,000 gift-tax annual exclusion with other gifts during 2011, yet you still want to contribute to your child's 529 college-savings account. One option you have is to set up a 529 account with yourself as beneficiary. Contributions to the account are not gifts, because according to the IRS you cannot make a gift to yourself. In a future year, when you have unused annual exclusion available, roll over part of your 529 account to your child's 529 account. And who knows, setting up a 529 account for yourself might even inspire you to go back to college some day.