The IRS imposes a federal tax on large gifts, including contributions to a 529 plan.
Luckily, thanks to the annual gift tax exclusion and the lifetime exemption, most people will never end up paying gift taxes, even after funding their child or grandchild’s college education.
In fact, only about 0.2% of taxpayers file a gift tax return each year. And only 0.5% of those that file a return end up having to pay the gift tax.
In this article, you’ll learn what the gift tax is, how it applies to 529 plans, and what to keep in mind about it when helping to pay for a loved one’s college education.
What is the Gift Tax?
The gift tax is a federal tax that applies when property is transferred (aka gifted) from one person to another.
Property transfers are considered gifts when:
- There’s no payment in exchange for the item
- There’s payment for the item, but it’s less than the item’s fair market value
- The gift’s giver doesn’t expect to receive the item back
Even if neither the giver nor the receiver considers the transfer to be a gift, the IRS considers it a gift if it meets the descriptions above.
When you make a transfer that meets the IRS definition of a gift, you may be required to file a gift tax return or pay gift taxes.
Parents and grandparents may read about the gift tax and worry that they’ll face a penalty for contributing to a loved one’s 529 college savings plan.
After all, a contribution to a 529 plan is considered a gift from the donor to the beneficiary, even if the donor is also the account owner. So, if you open a 529 account for your child and contribute money, you’re gifting that money to your child. But due to an annual exclusion and a lifetime exemption, you probably won’t end up paying gift taxes at all.
Annual Gift Tax Exclusion
Giving someone a gift doesn’t automatically require you to file a gift tax return or pay gift taxes.
Taxpayers don’t have to file a gift tax return as long as their total gifts are less than the annual gift tax exclusion amount per recipient. The annual gift tax exclusion is $17,000 per recipient in 2023 ($34,000 for a married couple giving jointly) and $16,000 in 2022.
Some examples of situations that could trigger someone having to file a gift tax return include:
- Contributing more than $17,000 in a year to your grandchild’s 529 plan
- Treating your friend to a vacation that costs more than $17,000 per person
- Loaning money to a friend or relative without charging interest
- Writing a check for more than $17,000 to help a friend out of a bad financial spot
- Giving multiple gifts during a single year totaling over $17,000
The gift tax allowance applies per gift recipient for each calendar year. This means you can gift multiple people up to $17,000 each in a year without having to file a gift tax return.
It also means that if you give someone multiple gifts throughout the year and the total value exceeds $17,000, then you must file a gift tax return.
Partners in a marriage can each give up to the gift tax exclusion before filing a gift tax return. For example, a grandfather and grandmother could each contribute $17,000 to a grandchild’s 529 plan. Even though they’ve given a combined $34,000, they wouldn’t have to file a gift tax return since neither surpassed the individual exclusion.
According to the IRS, there are a handful of situations where you may give a gift of more than $17,000 without having to file the gift tax return.
Those situations include:
- Tuition or medical expenses paid for someone else directly to the institution
- Gifts to your spouse, as long as your spouse is a U.S. citizen
- Donations to political organizations, nonprofit organizations and charities
Keep in mind that while the IRS doesn’t consider a direct tuition payment a taxable gift, the tuition payment may be treated as cash support and reduce the student’s eligibility for need-based financial aid.
There is also a special exception to the annual exclusion that applies to 529 college savings plans that allows you to front-load contributions without exceeding the limit.
Superfunding a 529 Plan
Taxpayers can also avoid paying gift taxes on 529 plan contributions with five-year gift tax averaging, also called superfunding.
This strategy allows taxpayers to make a lump sum contribution to a 529 plan of up to five times the annual gift tax exclusion, if the contribution is treated as if it were spread over a five year period. That means you can contribute up to $85,000 to a 529 plan ($170,000 if married giving jointly) in a single year and not owe any gift taxes.
However, any additional cash or property gifts you make to the same beneficiary during the five-year period will reduce the amount of exclusion available for your 529 plan contributions.
One potential drawback to superfunding is that if a gift giver dies within the five-year period, a portion of the gift will be added back to their estate and may be subject to gift taxes.
If you decide to frontload, or superfund, your 529 plan, you’ll have to file IRS Form 709, the gift tax return in each of the five years to indicate that contribution is being spread over five years.
Lifetime Gift Tax Exemption
Gifting more than $17,000 to an individual in a calendar year means you must file a gift tax return, but it doesn’t necessarily mean you’ll pay gift taxes.
In addition to the annual gift tax exclusion, there’s also a lifetime gift tax exemption. Anytime you give more than the annual gift tax limit in a single year, the excess contribution will count against your lifetime gift tax exemption.
The lifetime gift tax exemption is $12.92 million in 2022 ($25.84 million for a married couple giving jointly). It’s been raised from $12.06 million for 2022.
Before 2018, the annual exemption was just $5.49 million.
With the passage of the Tax Cut and Jobs Act (TCJA), Congress doubled the exemption. But that increase only applies for the years 2018–2025. Without further legislative action, the lifetime exemption will revert to $5.49 million in 2026.
Aggregate Limits for 529 Plans
Some grandparents may want to pay for a grandchild’s complete college education. In most cases, it is possible to fully fund a child’s 529 plan without having to pay gift taxes.
Each state has a maximum aggregate limit that applies to their 529 plans. Aggregate contribution limits range from $235,000 to $550,000, which is based on the full cost of attending college and graduate school in that state. . You can’t make further contributions to a 529 plan after it reaches the aggregate limit, though the 529 plan can continue to earn a return on the investments.
It is possible to contribute more than the aggregate limit if you open a 529 plan in another state, since each state’s aggregate limit doesn’t consider contributions to other states’ 529 plans. But, per IRS rules, any contributions above the state’s aggregate limit must be intended to cover a beneficiary’s college costs.
Grandparents who contribute the maximum amount to a grandchild’s 529 plan can avoid paying gift taxes by using up part of their $12.06 million lifetime exclusion.
For example, married grandparents in California may contribute a maximum $529,000 to a California 529 plan. If they decide to contribute the full amount as a lump sum in 2023, the first $34,000 will qualify for the annual exclusion. The remaining $495,000 is reported on IRS Form 709 and counted against their lifetime exclusion. Each grandparent will have to file separately since there are generally no joint gift tax returns.
The grandparents’ combined lifetime exclusion is $25.84 million in 2023. After subtracting the $495,000 in 529 plan contributions, they are left with a remaining lifetime gift tax exemption of $25.345 million (assuming no other gifts were made).
The Generation Skipping Transfer Tax and 529 Plans
Grandparents contributing to a grandchild’s 529 plan will also be subject to the Generation-Skipping Transfer tax (GST). The tax applies when someone transfers property to someone who is at least 37.5 years younger than themselves. The purpose of the tax is to prevent grandparents from avoiding taxes by transferring their inheritance to their grandchildren instead of their children.
Like other financial gifts, when a grandparent contributes to a grandchild’s 529 plan, the amount will count against their lifetime exemption. If their total gifts exceed the lifetime exemption, the gift tax is a 40% flat tax.
529 Plans and Estate Taxes
When your assets are passed on after your death, your loved ones may have to pay an estate tax on those assets.
Since 1916, the United States has imposed a tax on estates that exceed a certain value. Some states also have an estate tax, an inheritance tax or both.
Earlier, we discussed the exclusions that apply to the gift tax — $17,000 per year and $12.92 million over one’s lifetime (in 2023).
But that lifetime exclusion is actually a combined exclusion for both the gift tax and the estate tax. The gift tax is paid by the donor while they are living, and the estate tax applies to the transfer of property when they die and is paid by their estate. As someone’s lifetime exclusion shrinks over the years as they give gifts, it reduces that person’s estate tax exclusion.
Congress combined the lifetime exemptions for the gift tax and estate tax so that taxpayers couldn’t avoid the estate tax by gifting their money to loved ones before they died.
529 plan contributions are exempt from federal estate taxes, but they are considered completed gifts for tax purposes. That means contributions above the annual exclusion amount are counted against the donor’s lifetime exclusion amount, which includes the estate tax exemption.
The exemption limits for state estate tax and state inheritance tax are much lower than the $12.92 million federal limit. However, it is unlikely that a 529 plan would be subject to either. A state’s inheritance tax typically doesn’t apply when the assets are passed down to a child or grandchild, and most states use the federal gross estate amount to calculate the state gross estate (which doesn’t include 529 plans).
Let’s look at a fictional example of a man named Robert.
Robert has a high-income, and each year gifts $20,000 to each of his three grandchildren. In total, Robert gifts $60,000 per year.
Because his annual gifts exceed $17,000 per person, Robert must file a gift tax return each year to report the excess $3,000 per grandchild. Because he hasn’t exceeded his lifetime exclusion amount, he doesn’t actually pay the taxes on those gifts.
Now let’s say Robert continues this annual gift for 20 years and then passes away. Over those 20 years, Robert gifted a total of $1.2 million to his grandchildren, but only $180,000 counted against his lifetime gift and estate tax exclusion. .
Remember, the IRS allows taxpayers to give an unlimited number of annual gifts of $17,000 or less per beneficiary without reducing the lifetime exemption.
Filing a Gift Tax Return
If you made any gifts (including 529 plan contributions) to a single beneficiary this year totalling more than $17,000 you will have to file a gift tax return (IRS Form 709).
Here are the steps to file a gift tax return:
Step 1: Figure out if you have to file a gift tax return
First things first, determine whether federal law requires you to file a gift tax return.
You generally must file a gift tax return if you transfer more than $16,000 of value to an individual in a single year.
If you gifted more than $17,000 but spread it out across several people, then you don’t have to file a gift tax return.
529 plan contributions between $17,000 and $85,000 must be reported on a gift tax return when using the five-year election, and you must indicate that the contribution is being spread ratably over five years.
Step 2: Decide if and how you and your spouse will split gifts
Each spouse in a marriage can contribute up to the individual annual exclusion.
For example, you could each gift $17,000 to a single person before you must file a return. Keep in mind that married couples generally cannot file joint gift tax returns — you each have to file your own.
If each partner plans to to file a gift tax return, decide who will claim each gift.
Step 3: Compile a list of your gifts
The gift tax return will require you to report any gifts to a single beneficiary in excess of $17,000.
Before filing your return, compile a list of qualifying gifts, including 529 plan contributions, so that you don’t forget any. It’s best to keep track of these gifts throughout the year in case you surpass the annual exclusion through multiple gifts.
Step 4: Fill out IRS Form 709
Form 709 is the gift tax return.
To complete it, you’ll generally have to:
- Complete lines 1–19 with general information
- List each gift on Part 1, 2, or 3 of Schedule A
- Complete Schedules B, C, D as necessary
- Complete Schedule A, Part 4
- Complete Part 1 and 2 — Tax Computation
- Sign and date Form 709
- File Form 709 with the IRS
Step 5: File Form 709 annually as necessary
You’ll have to file Form 709 each year that you exceed the $17,000 gift exclusion for a single recipient. If you choose to superfund a child’s 529 plan, you’ll have to file the Form 709 for each of the five years.
It’s important to note that most people will never end up paying a gift tax.
It’s not until you exceed the $12.92 million lifetime exclusion that you must start paying the gift tax. But for each year that you surpass the $17,000 annual exclusion, you have to file the return and the excess will be subtracted from your lifetime exclusion. Like your income tax return, the gift tax return is due by April 15 for gifts given during the previous calendar year.
You may be subject to gift taxes when you make large contributions to a 529 plan.
But thanks to the IRS annual and lifetime exemptions, most people will never actually have to pay the gift tax.
While you are required to file a gift tax return if your annual gifts to an individual exceed $17,000 (including 529 plan contributions), it’s not until you exceed the lifetime exemption of $12.92 million that you are subject to gift tax.
If you believe you may have to file a gift tax return or pay gift taxes, consult a tax professional or see the IRS Form 709 for the next steps.