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What Is It?

Your payment of someone else's tuition is a qualified transfer (a nongift gift). You are allowed to make this type of gift without incurring federal gift tax or federal generation-skipping transfer tax (GSTT). The payment must be: (1) for tuition, (2) made to a qualified educational organization, and (3) made directly to the educational organization. This exclusion allows you to pay an unlimited amount and is in addition to the annual gift tax exclusion. Often overlooked, this exclusion is a great way to transfer wealth to children and grandchildren.

When Can It Be Used?

When Payment Is For Tuition

To avoid it being a gift for gift tax purposes, the payment must be for tuition only. Payments for costs such as supplies, books, dormitory fees, and board do not qualify for the exclusion.

When Payment Is to a Qualified Educational Organization

You must make the payment to an educational organization that meets conditions set out by the IRS. Each of the following requirements must be satisfied. The organization must:

  • Maintain a regular faculty
  • Offer a regular schedule of courses
  • Enroll students on a regular basis
  • Have a place where it regularly carries out its educational activities

Example(s): The Correspondence School of Radio Broadcasting offers a correspondence course to students. It is not a qualified educational organization because it has no place where it regularly carries on educational activities. Tuition paid to this school does not qualify for the exclusion.

When Payment Is Made Directly to the Educational Organization

The payment can be made on behalf of anyone (i.e., it need not be a relative), but you must make the payment directly to the educational organization. Payments you make to the student will not qualify.

Strengths

Allows You to Make a Tax-Free Gift

Generally, gifts you make are subject to gift tax. The IRS considers payments for tuition made to a qualified educational organization on behalf of a student to be nongift gifts, which are not subject to gift tax or the generation-skipping transfer tax. This can be a great way to transfer wealth to your children and grandchildren.

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Allows You to Save Your Applicable Exclusion Amount

You are allowed to pass a certain amount of your property free of federal gift and estate tax under the applicable exclusion amount (the amount that be sheltered from gift tax and estate tax by the unified credit). Because gifts of tuition are not subject to gift tax, you don't need to use the applicable exclusion amount to offset these gifts.

Allows You to Stretch the Annual Gift Tax Exclusion

Because gifts of tuition are not considered gifts for gift tax purposes, you can still give the student up to $15,000 (in 2020) tax free under the annual gift tax exclusion.

May Reduce Estate Tax Liabilities

Making a gift of tuition can reduce your estate tax liability by removing the value of the payment from your gross estate.

Allows You to Provide an Education for Someone

Paying for another's tuition can be a personally gratifying act.

Applies To both Full-Time and Part-Time Students

The gift qualifies if it is in payment for the tuition of one or more courses.

Applies To a Foreign Educational Organization

Unlike other types of charitable gifts that must be made to organizations located in the United States, a gift of tuition on behalf of another person can be made to a foreign educational institution.

Tradeoffs

Does Not Apply To Some Types of Educational Expenses

The IRS will not allow the exclusion if you make a gift for expenses that are not direct tuition costs. The most common examples include:

  • Fees
  • Books
  • Living expenses
  • Supplies

May Have Negative Income Tax Consequences for Third Persons

If a dependency relationship exists between the student and another person, the tuition payment that you make will count in the calculation of the student's support. This could affect who can claim a dependency exemption for the student and could affect the parent's or student's ability to claim a personal exemption.

Example(s): If by making tuition payments, Grandma provides more than half the support for her granddaughter during the year, Grandma would be entitled to claim a dependency exemption on her income tax return for the year of the payment.

How to Do It

Make the Gift Directly To the Educational Organization

To qualify, you must make the payment directly to the educational organization. Giving the payment to the student or to a trust on behalf of the student will not qualify.

Example(s): Kevin attends X University. His friend, Rob, wants to make a $25,000 tax-free tuition gift. To avoid gift taxes, Rob makes the check payable to X University, not to Kevin, and sends it directly to the school.

Get a Receipt

If the IRS audits you, you may have to prove that you made the payment directly to the educational organization. Therefore, get a receipt and keep it with your tax records for that year.

Tax Considerations

Income Tax

May Have Negative Income Tax Consequences for Third Persons

If a dependency relationship exists between the student and another person, the tuition payment that you make will count in the calculation of the student's support. This could affect who is eligible to claim a dependency exemption for the student and could affect the parent's or student's ability to claim a personal exemption.

Example(s): If by making tuition payments, Grandma provides more than half the support for her granddaughter during the year, Grandma would be entitled to claim a dependency exemption on her income tax return for the year of the payment.

Gift and Estate Tax Avoids Gift and Generation-Skipping Transfer Taxes

Payments of tuition for another person, no matter for whom and no matter the size, are not gifts and are not reported at all on the federal gift tax or federal generation-skipping transfer tax returns, as long as the payment is made directly to the educational organization. It also allows you to stretch the annual gift tax exclusion.

May Reduce Estate Tax Liabilities

Making the gift can reduce your estate tax liability by removing the value of the payment from your gross taxable estate. It also allows you to save your applicable exclusion amount.

Questions & Answers

Does The Exclusion Apply To College Tuition Only?

No. The exclusion applies to tuition for any level of education as long as it is to a qualified educational organization. Therefore, you can exclude payments for your younger child's parochial school tuition, as well as your older child's graduate school tuition.

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

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