Carolyn A. Hegge
Providing for the college education of your children or grandchildren may be one of your estate planning goals. There are a number of ways that you can achieve this goal in a tax-efficient manner.
Unlimited Gift Tax Exemption for Tuition Paid Directly to an Educational Institution. Whenever you make a contribution toward your child or grandchild’s college education costs, a gift is being made to the child or grandchild and that gift is subject to the federal gift tax. The good news is that there is an unlimited federal gift tax exemption for gifts of tuition (and only tuition) that are paid directly to qualifying primary, secondary or postsecondary educational institutions (“Qualified Tuition Gifts”). To qualify for this exemption, the tuition check must be made payable to the educational institution, not to the student. There is no limit on the size of a Qualified Tuition Gift or on the number of Qualified Tuition Gifts that you can make in a year. If the Qualified Tuition Gift is used to pay the tuition of a spouse or dependent at a post-secondary education institution, you may also be entitled to an income tax deduction for all or part of the Qualified Tuition Gift — see your tax advisor for more information about when tuition payments are deductible for income tax purposes. Although a Qualified Tuition Gift is exempt from federal gift tax, it may be taken into account by a college’s financial aids office when it makes need-based financial aids awards.
529 Savings Plan Accounts. A 529 Savings Plan is a tax-advantaged savings plan designed to encourage people to save for college costs. 529 Savings Plans are sponsored by the states. Wisconsin has two 529 Savings Plans, “Edvest” and “Tomorrow’s Scholars.” Edvest is available on a direct sales basis whereas Tomorrow’s Scholars is only available through financial advisors.
A 529 Savings Plan Account is established for a specific beneficiary. The owner of the 529 Savings Account can change the beneficiary of the account, but the new beneficiary must be a member of the original beneficiary’s family. However, there may be gift tax consequences if the new beneficiary is not of the same generation as the original beneficiary. Consult your tax advisor before you change the beneficiary of a 529 Savings Plan Account to a beneficiary who is not of the same generation as the original beneficiary.
Income earned within a 529 Savings Plan Account is not subject to income taxation. Withdrawals from a 529 Savings Plan Account are not subject to income taxation if used to pay the qualified education expenses (i.e., tuition, room and board, mandatory fees, books and computers (if required)) of a student enrolled at least half-time at an eligible post-secondary educational institution.
Contributions to 529 Savings Plans are subject to the federal gift tax. Although contributions to 529 Savings Plans are subject to the federal gift tax, a donor can use his or her annual gift tax exclusion to shelter contributions from the federal gift tax. In fact, a donor can elect to pre-fund a 529 Savings Plan Account with up to five years’ worth of annual gift tax exclusions — the annual gift tax exclusion amount is currently $14,000 per donee which means that a donor could contribute up to $70,000 to a 529 Savings Plan Account in 2014 free of the federal gift tax as long as the donor did not make other taxable gifts to the beneficiary during the 5-year period. You should consult your tax advisor to learn more about this election.
Contributions to 529 Savings Plans are not deductible for federal income tax purposes. However, Wisconsin residents get a Wisconsin income tax deduction for the first $3,000 that they contribute to a Wisconsin 529 Saving Plan for themselves or certain relatives each year. The $3,000 deduction applies to each Wisconsin 529 Saving Plan. For example, if you contributed $3,000 to a Wisconsin 529 Savings Plan for your son in 2014 and you also contributed $3,000 to a Wisconsin 529 Savings Plan for your daughter in 2014, you could deduct $6,000 on your 2014 Wisconsin income tax returns.
To learn more about Wisconsin’s 529 Savings Plans, go to https://www.edvest.com/ or to http://529plans.inginvestment.com/Wisconsin/index.htm#.Uqh75meA3L8. To learn more about 529 Savings Plans in general, go to http://www.irs.gov/pub/irs-pdf/p970.pdf.
529 Pre-paid Tuition Plans. 529 Pre-Paid Tuition Plans are plans set up by states or by private or public educational institutions to allow you to prepay a student’s qualified education expenses. Some plans even allow you to lock in tuition costs at current tuition rates. The gift and income tax treatment of 529 Pre-Paid Tuition Plans is generally the same as for the 529 Savings Plans discussed above. You should check the plan documents to see what happens if the beneficiary decides to attend a different school than the one for which the plan was established.
Wisconsin has a 529 Pre-Paid Tuition Plan, but it is currently closed to new accounts. Illinois, Michigan and several other states have 529 Pre-Paid Tuition Plans that are open to new accounts, and you can find out more information about those plans at http://www.collegesavings.org/index.aspx. Also, over 270 private colleges, including several in Wisconsin, have joined together to offer a pre-paid tuition program called “Private College 529 Plan.” By purchasing a tuition certificate in the Private College 529 Plan, a donor locks in today’s tuition rates at all of the private colleges that participate in that Plan. Go to https://www.privatecollege529.com/OFI529/ to learn more about the Private College 529 Plan.
Coverdell ESA Accounts. A Coverdell Educational Savings Account (Coverdell ESA) is a tax-advantaged savings account that generally has the same income tax advantages, and the same gift tax consequences, as a 529 Savings Plan. However, there are some important differences:
There are other differences too. Go to http://www.irs.gov/pub/irs-pdf/p970.pdf to learn more about Coverdell ESAs.
If you have any questions about how the information in this article may affect you or your business, please contact Carolyn Hegge at chegge@stroudlaw.com or (608) 257‑2281 or your Stroud attorney.
DISCLAIMER: The information in this article is provided for general informational purposes only, is not necessarily updated to account for changes in the law, and should not be considered tax or legal advice. This article is not intended to create, nor does the receipt of it constitute, an attorney-client relationship. You should consult with your own legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.
