April 2000


By Marc A. Aaronson, JD, LLM, CPA, and Richard A. Eisner & Company, LLP

Many grandparents help their cash-strapped children with high educational expenses by paying their grandchildren's tuition directly to the schools. These payments qualify for the unlimited gift tax tuition exclusion [IRC section 2503(e)] and are gift tax-free in addition to annual exclusion gifts.

Grandparents or other older donors with short life expectancies often wish to get more out of their estate than just one year's tuition without any gift tax. One way is by making gifts to individuals through the college savings plans that are available in many states. These gifts, however, generally are subject to the $10,000 per person per year exclusion limit. They do not qualify for the unlimited tuition exclusion because the payments are not made directly to an educational institution. They also cannot be used to pay for elementary or high school tuition.

Another method of paying more than one year's tuition is to fund a trust, the terms of which provide that distributions may be made only to educational institutions for tuition on behalf of a beneficiary. However, Treasury Regulations section 25.2503-6(c), Ex. 2, states that gifts to such trusts do not qualify for the tuition exclusion because the donor's payments are not made directly to an educational institution. In addition, these gifts generally do not qualify for the annual $10,000 exclusion because a gift to a trust is a future interest (the beneficiary does not have a present or immediate right to use, possess, or enjoy the property or its income).

In a recent technical advice memorandum [TAM 199941013], the IRS approved an unlimited tuition exclusion for prepaid tuition for the benefit of a designated individual. The facts of this ruling involved a grandparent who prepaid nine years' worth of tuition (more than $163,000) for her grandchildren at a private school providing classes from preschool through 12th grade. The payments were for tuition for specific years, but were not refundable even if a grandchild ceased to attend the school. In addition, the grandparent and the father agreed that if there were a tuition increase, the school would be paid the additional amount to cover the increase.

The IRS ruled that all of the grandparent's tuition prepayments qualified for the exclusion because they were made on behalf of designated individuals as tuition and paid directly to an educational institution. The payments do not have to be for the current year's tuition in order to qualify for the unlimited exclusion. The exclusion, however, applies only to tuition. Other educational expenses such as books, supplies, dormitory fees, and board do not qualify for the tuition exclusion [Treasury Regulations section 25.2503-6(b)(2)]. In addition, the donor does not have to be related to the donee and the tuition can be for elementary or high school education.

Direct tuition gifts do not have to be reported on a gift tax return. In addition, since these gifts are not included in the gross estate, they may help in qualifying an estate for IRC section 303 stock redemption treatment, IRC section 2032A special use valuation, and IRC section 6166 deferred payment of estate tax.

Note: A similar unlimited gift tax exclusion exists for payments made on behalf of an individual directly to the provider of medical insurance or qualified medical care [IRC section 2503(e)]. Based on the facts of the ruling, it would appear that medical expense prepayments may qualify for the unlimited gift tax medical exclusion if the payments are made directly to the provider of the qualified medical services on behalf of a designated individual. It is unclear whether such prepayments must be nonrefundable in order for the exclusion to apply. *

Lawrence M. Lipoff, CPA
Deloitte & Touche LLP

Alan D. Kahn, CPA
The AJK Financial Group

Contributing Editors:
Jerome Landau, CPA

Debra M. Simon, CPA
Merdinger Sruchter Rosen &
Corso P.C.

Richard H. Sonet, JD, CPA
Marks Paneth & Shron LLP

Peter Brizard, CPA

Ellen G. Gordon, CPA
Margolin Winer & Evens LLP

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