 Accounting
Best Practices
Who Says
Christmas and Hanukkah Only Happens Once a Year?
Generally
any cash gifts to an individual in excess of $12,000 are
subject to an annual "gift tax". There is however a
lifetime exemption of $1,000,000 on gifts (per donor)
that exceed this annual limit. Many people have
accumulated significant wealth over their lifetime and
may wish to reduce their estate before their death to
ensure they pass along the maximum financial benefit to
their heirs. One way to do this is to "gift” cash each
year as mentioned above. This method of reducing their
estate is limited by the gift and generation skipping
transfer tax limitations.
There are
two predominant ways one can minimize the effects of the
aforementioned annual and lifetime giving limitations.
The first method would be to pay for an individual’s
private school tuition. In a private letter ruling (PLR
200602002) the IRS has recently ruled that certain
tuition pre-payments made on behalf of another may be
excluded from both gift tax and generation skipping
transfer tax liability. The private letter ruling (i)
included the fact a Grandparent (the “Donor”) proposed
to pre-pay tuition for the same private school for all
six of his grandchildren, and (ii) concluded that these
payments would not be subject to the gift and generation
skipping transfer tax limitations. In order to qualify,
any such payments must:
-
be made
directly to the school;
-
be used
for the student's tuition;
-
be
adequate to cover the cost of tuition with any
shortfalls made up either by the donor or the
student’s parents; and
-
be
non-refundable and subject to forfeiture to the school
if the funds are not used for tuition.
As
mentioned in the last bullet above, perhaps the most
important point of these types of arrangements are that
the tuition payments are nonrefundable, and, once
paid, become the property of the educational
institution. In addition, the prepayment agreement
discussed below cannot provide for any promises of any
additional rights or privileges over any
other student or enrollment. Accordingly, if the child
fails to qualify for admission, and/or remain enrolled
in the school for any reason whatsoever, the prepaid
tuition will be forfeited. As such, this requirement is
a two edged sword that could result in a donor making a
very generous, albeit unintended, charitable
contribution to such school.
Conversely, the advantage of pre-payments is the
guarantee that the death of the donor before the
completion of the donee’s education would not prevent
the full use of the donor’s ability to make tax-free
tuition payments for the donee.
As an
example, the annual tuition to attend Columbia Grammar
and Preparatory School in New York for pre-K through 12th
grade averages approximately $26,000 per year. This
private letter ruling would permit the Grandparent to
transfer up to $338,000 (i.e. $26,000 for 13 years) for
each of the six grandchildren without any gift or
generation-skipping transfer tax concerns. The total
transfer to the school for the grandchildren to attend
would be approximately $2,028,000, entirely tax-free.
Because Code Section §2503(e) extends to college, an
even greater benefit can potentially be achieved by the
funding of college tuition.
It is
also important to note that the grandparent and the
school must have a written agreement, and that payments
must be made directly to the educational institution in
lieu of the grandparent making the payments to the
parent or grandchild and then having them make the
payments to the institution as the latter arrangement
fails the gift tax exclusion under Code Sec §2503(e).
As such,
in our example, the Donor should have his
attorney create a separate agreement between the
school and him for each grandchild, which calls for them
to prepay a specified amount of annual tuition for the
grandchildren. The amount to be paid under the agreement
should be determined based on the current tuition rates
charged by the school and set forth on a schedule
attached to the agreement. If the Donor chooses to
continue to make the annual gifts, the Donor would
acknowledge that any tuition increase would be made up
by the Donor or by the parents of the children. Consent
to the agreement would also need to be made by the
parents. Section §2503(e) of the Internal Revenue Code
also provides for a second way to minimize the effects
of the estate tax by also exempting medical expenses,
including the payment of health insurance, from any gift
tax or generation-skipping tax liability. So, this same
private letter ruling may also be applied to the
pre-payment of a lifetime worth of health insurance
premiums for all of the Donor's grandchildren.
While we
have used a Grandparent/Grandchild relationship in our
discussion above, the strategies can be used by any
individual, related or otherwise, who pays tuition to a
qualified institution on behalf of another individual
for the education or training of such individual, or to
any individual who provides qualified medical care with
respect to such individual as payment for such medical
care.
It has
been said that the next best thing to being rich is
having rich relatives and/or friends. So for any of you
who have children who are so blessed, perhaps you should
consider asking them to modify their Christmas/Hanukkah
gift lists this year to request prepayments of tuition
and health care prepayments. Now that’s a gift
that even the IRS can appreciate!
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Paul Bayer is currently a member of the
tax department and has many years of experience working
in public accounting in both audit and tax. Prior to
his public accounting career, he worked in the Corporate
Controller’s division for MetLife where he specialized
in Derivatives accounting and Private Placement
Investments accounting. Kingery & Crouse, P.A. is a
full service public accounting firm with a staff of
dedicated professionals providing tax and accounting
services, including audits of SEC companies. You may
contact Paul at (813) 874-1280 ext #247. Find us on the
web @
www.tampacpa.com.
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Published September 2007,
Volume 1, Number 6,
Bay
Area Business Magazine
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