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Paying For College: Understanding the Tax on Gifts

By — John Wiley & Sons, Inc.
Updated on Oct 26, 2010

Whenever you, your child's grandparents, or any other relatives make any contribution toward your child's education, a gift is being made to your child. And, because the IRS never leaves any good deed unpunished, that gift becomes subject to the Gift Tax and/or Generation-Skipping Transfer Tax (GSTT). Yep — right when you think you've done something nice for someone, the IRS has to slap some kind of tax on it. There is good news, however, and you can find it in the following sections, where I show you how to make the most of your goodwill by explaining the rules surrounding the Gift Tax and the GSTT.

If ever a topic defied easy explanations, it's the transfer tax, which is the slice the government takes when money is given from one person to another, either in a lifetime gift or an after-death inheritance, and which includes the Gift Tax and GSTT. You can easily go wrong when trying to figure out these taxes, and mistakes are costly to repair. If, after you read what follows, you have some gift tax or GSTT questions, please run, don't walk, to a qualified tax advisor, whether an accountant, a lawyer, or an enrolled agent (a person qualified by the IRS to advise clients on tax issues). The relatively small amount you may spend upfront for advice is peanuts in comparison to the amounts you may have to cough up if you don't play by the IRS rules.

Understanding The Gift Tax

If you, and your extended family and friends, are planning and plotting ways to see your child, or children, through college and beyond, you may begin a gifting program early in your child's life. Every year, every person is entitled to make gifts, tax free, to as many other people as he or she wants, up to the annual exclusion amount. This amount is adjusted periodically to reflect inflation. (The amount was $13,000 in 2009.) So, for example, if you have three children, you, your spouse, your parents, and anyone else who has the means and the desire, can each transfer $13,000 (or the current exclusion amount) to each of the deserving people on your list, without incurring any gift-tax consequences. Next year, you can do the same thing again.

Now, the IRS, in its infinite wisdom, realizes that handing a 7-year-old a check for $13,000 probably isn't a wise move, and this is one time (and maybe the only time) that you probably agree with the IRS. Accordingly, the IRS allows you to make gifts into financial vehicles, such as in trust, in UGMA/UTMA accounts, in Section 529 Plans, and in Coverdell Savings Accounts, for your children (or grandchildren, or anyone else you want to make gifts to), that hold and maintain that money either for a specific period of time or a for specific purpose. No matter whether you gift cash, stocks or bonds, jewelry, or anything else, if you give up your interest in the property, the gift qualifies as a completed gift, and you can deduct the annual exclusion amount ($13,000) from the total value of the gift. Any amount you've gifted over and above the annual exclusion amount is now subject to the gift tax rules.

For example, if Auntie Elizabeth gives your child $20,000 in 2009, $13,000 is excluded from that gift, and $7,000 is subject to the gift tax. If Auntie Elizabeth and Uncle Bob (who are married to each other) each give your child $20,000, then $26,000 of their total gift qualifies as annual exclusion gifts (2 x $13,000), with $14,000 subject to the gift tax.

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