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Utilizing your $12,000 gift tax annual exclusion
by Joe Hurley, founder,
Sunday, September 17th 2006

[Updated March 27, 2008]

With 529 plans you have a unique opportunity to remove assets from your taxable estate without giving up ownership and control of those assets. However, because your contributions to the 529 plan are considered a completed gift from you to the designated beneficiary you need to understand and plan for any gift-tax ramifications.

Fortunately, your $12,000 gift tax annual exclusion can be employed to keep your 529 contributions from becoming "taxable" gifts. Even better, if you contribute more than the $12,000 annual exclusion amount to 529 plans for any particular beneficiary, you are allowed to spread as much as $60,000 (five times the annual exclusion amount) over five years for gift-tax purposes. Assuming you make no other gifts to that individual over the five-year period, your 529 contributions do not result in taxable gifts.

If you have no taxable gifts, you are not required to file the Form 709 gift tax return. However, to make the five-year election you must file Form 709 for the year of the election even when the effect of the election is to eliminate an otherwise-taxable gift. Form 709 does not have to be filed for years subsequent to the election year provided you have no taxable gifts to report in those subsequent years.

Here are a few things to remember when making substantial contributions to a 529 plan:

  • Consider the impact of your other gifts during the year. If you give your child some stocks worth $5,000, and you make a $10,000 contribution to a 529 account for that child in the same year, your total gifts are $15,000. After applying your $12,000 annual exclusion you're still left with $3,000 in taxable gifts. (Note: because the 529 contribution itself does not exceed $12,000, it appears the five-year election is not available in this situation.)

  • The five-year election cannot be used to spread 529 contributions over and above five times the annual exclusion amount. If you make a $70,000 contribution this year, $60,000 can be spread over five years, but the $10,000 excess will be counted as this year's gift, leaving you with $22,000 in total gifts for the current year.

  • Because everyone has a $1 million lifetime exemption, you don't actually start paying gift taxes to Uncle Sam until your cumulative taxable gifts exceed $1 million. For most people, the gift tax is not going to be much of a problem (except maybe for the hassle of filing Form 709 when necessary).

  • If married, you and your spouse together have $24,000 in annual exclusions for every beneficiary, a maximum $120,000 in accelerated 529 contributions using the five-year election, and $2 million in combined lifetime exemptions. In any year, you may agree to split your gifts, which means that each of you is treated as making one-half of your total combined gifts. See the Form 709 instructions. Gift-splitting can be very useful when making uneven gifts; there is no such thing as a joint gift-tax return.

  • Grandparents funding 529 accounts for grandchildren also have to consider the generation-skipping transfer tax. Fortunately, the $12,000 annual exclusion, the five-year election, and a $2 million exemption are available for generation-skipping transfers.

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