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529 E-ditorials

03-6: An annual exclusion is a terrible thing to waste
Joe Hurley
Sunday, December 21st 2003

In the few days we have left before the end of this year, you have an opportunity to reduce your taxable estate by making gifts within your $11,000 per-beneficiary gift tax exclusion. Many Americans will miss this opportunity. Once the calendar turns over, you'll get your 2004 exclusions, but you'll also be leaving behind 2003's unused exclusions.

Let's briefly review. If, for example, you have six grandchildren, you can gift $11,000 to each of them this year, or $66,000 in total. If you're married, your spouse can do the same for those six grandchildren, and together you've removed $132,000 from your combined estates, along with all future growth of those assets, without incurring any gift taxes. Your heirs stand to gain tens of thousands of dollars (or more) that Uncle Sam might otherwise claim upon your death.

So why doesn't every well-off individual fully utilize his or her annual exclusions? I assume it's because most people don't really like the idea of giving away their hard-earned dollars. In order for you to claim the $11,000 exclusion and reduce exposure to future estate taxes, the gift must be irrevocable, and it must be made without any strings attached (except for what your attorney may be able to craft through a trust or family partnership). What's yours now no longer belongs to you, and that can be a tough pill to swallow.

Unless, of course, we're talking about a 529 plan.

The tax law permits you to retain full control over your 529 account. In most plans, you have the right to change the beneficiary to another family member, direct the use of distributions, and even ask for the money back at any time (subject to tax and penalty on the earnings). Yet your contributions to the 529 plan are treated as gifts from you to the account beneficiary, and those gifts qualify for the $11,000 annual exclusion. It's quite extraordinary. Even more amazing is that you may elect to spread large contributions (as much as $55,000 per beneficiary) over five calendar years for gift tax purposes. This is often referred to as "accelerated gifting," and it's only available through 529 plans.

Perhaps you're thinking "so what?" Thanks to the lifetime gift/estate exemption, you may not expect your estate to be subject to tax anyway. The exemption against estate taxes is increasing from $1 million in 2003 to $1.5 million in 2004. It increases again to $2 million in 2006, and to $3.5 million in 2009. And in 2010, the federal estate tax is completely gone. So why worry about it now?

There are at least two reasons to worry. The first is that the tax breaks enacted in 2001 are scheduled to expire at the end of 2010. Unless new legislation is passed in Washington, the estate tax will return in all its fury on January 1, 2011, and the lifetime exemption will retreat to $1 million. The second reason is that even when an estate doesn't owe federal estate tax, taxes may still be owed to the state. A recent article in Business Week highlights the fact that 25 states plus the District of Columbia will be collecting tax from some estates (or the heirs) that fall below the federal-tax radar.

We can't be sure that Congress and the President will act to protect estates from tax after 2010, particularly when federal budgets are severely strained. In the meantime, a 529 plan can make a lot of sense as a way to remove assets from your estate without removing your ability to control those assets. Not to mention, it will help put your children or grandchildren through college.

Here are a few additional tips concerning 529 plans and gifting:

- Count up all your gifts during the year when planning your contributions to a 529 plan. If you contribute $11,000 to a 529 plan, and make another $300 of cash gifts to your beneficiary during the year, your total gifts are $11,300 and you have exceeded the annual exclusion. If you use Upromise, Babymint, the Fidelity MasterCard, or other affinity programs to sweep your rewards into a 529 plan, you should count those as gifts too.
- Be sure your contribution gets made early enough to be counted as a 2003 gift if that is your intention. Leave enough time for your check to be received and credited to your 529 account. If you qualify for a state income tax deduction for your contribution, be sure to check the rules in your state regarding the timing of the contribution.
- If you make 529 contributions exceeding $11,000 for a beneficiary, you may elect to spread those contributions (but not more than $55,000) over a five-year period for gift-tax purposes. You must file Form 709 separately with the IRS in order to make that election. Form 709 has the same filing due dates as Form 1040. If you failed to file Form 709 for a prior year election, go ahead and file it now. There's no late-filing penalty.
- Carefully coordinate your gifting with your spouse. You may consent to split your gifts, but check the Form 709 instructions to determine how to indicate such consent. If your 529 contributions after gift-splitting still exceed $11,000 each, you and your spouse should make separate five-year spreading elections.

» 05-4: The 529 marshals have arrived - 08/30/05
» Our 5.29th-year anniversary - 06/29/05
» 05-2: 529s and the new Bankruptcy Act - 04/28/05
» 05-1: Reform or Deform? - 02/27/05
» 04-6: Perspectives on the 529 debate - 12/28/04
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