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COLLEGE SAVINGS 101

Excessive 529 contributions easily fixed

03/17/2008

QUESTION:
Dear Joe,

My wife and I have a 529 college savings plan for my daughter, but we just determined that my wife accidentally contributed $25,000 to the plan instead of the current IRS annual maximum of $24,000 for a tax year. (My wife and I file our tax returns jointly and have not yet filed our tax returns for tax year 2007).

We don't want to pay a federal gift tax on the $1,000 excessive contribution amount and are trying to identify our options. We contacted our 529 college savings plan administrator to see if it could back out $1,000 from our 2007 contributions and were told that could not be done. My wife and I are looking for advice and hope you can assist us.

-- Rich M.

ANSWER:
Dear Rich,
Don't worry -- your problem is a small one. However, you do have a decision to make and federal gift-tax forms to file.

The law generally allows an individual to make gifts of up to $12,000 each year to any other individual without creating a "taxable" gift, thanks to the gift-tax annual exclusion. By agreeing to "gift-splitting," a married couple treats each gift as being made equally by both spouses, producing a combined $24,000 gifting allowance.

Your wife's $25,000 contribution to a 529 plan for your daughter means that each of you has made $12,500 in gifts. Under the usual gifting rules, this would require each of you to report a taxable gift of $500 to the federal government.

However, each American has a $1 million lifetime exemption against taxable gifts. You won't actually pay federal gift tax until your cumulative taxable gifts exceed the $1 million threshold. If you have not made any other taxable gifts during your lifetime, you'll still have $999,500 of unused exemption available after 2007.

Another option available to each of you (and applicable to 529 plans only) is to make the special five-year election that allows you to spread your $12,500 in contributions ratably over five years for gift-tax purposes only. This way, you will be treated as having made a $2,500 gift for each year 2007 through 2012, which is well below the annual exclusion amount.

So, here's your choice: Either you and your wife each report a taxable gift of $500 in 2007 against your $1 million lifetime exemption, or you elect five-year treatment and stay below the threshold but use up a portion of your exclusion for each of the next four years.

Either way, you and your wife must file Form 709 Gift Tax Return for 2007. (There's no joint return and the due date is April 15). Most people in your situation would choose to make the five-year election on Form 709. It's easy to do and is explained in the instructions for Form 709, available online at www.irs.gov.

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