Plus, proposed legislation could change 529 use with student loans, and more.
Question: First, a grandfather passed away and left at death $500,000 in a trust for his grandchildren (in a generatio-skipping transfer trust). The trustee is considering investing in 529 plans for the underlying grandchildren. My question revolves around the grandmother wanting to make additional gifts into these new 529 plans. I read in your Nov. 20, 2009 article that a donor could make a contribution directly to a 529 plan owned by a trust as long as the state allowed non-owners to make contributions. Are there any complications that I am missing?
Second, the son of the grandfather above has already established personally owned 529 accounts for his children (i.e., the grandchildren above). He is inquiring about transferring the existing 529s for each of the beneficiaries into a new 529 that would be owned by the GST trust. To your knowledge, could this be done? If this is available, what occurs if all of the funds are not utilized for that beneficiary's education needs and there have been two different contributors (GST trust and the father)? Would there be any special accounting in this case? Or is this just like the first question I posed?
Susan: First, I assume that when you say the grandfather left $500,000 in a GST trust that grandfather's GST exemption was assigned to the trust so that it has a zero inclusion ratio and that distributions from the trust to grandchildren or great grandchildren will not be subject to the generation-skipping transfer tax. (This would require that grandfather died before 2010, because in 2010 the GST tax rules are not in effect, and, therefore, there is no GST exemption that can be assigned.) I also assume that gifts to the trust do not qualify for the gift-tax annual exclusion because typically trusts established at a grantor's death have no need to qualify for the gift-tax annual exclusion. Further, one would not usually use a single trust for multiple grandchildren for annual exclusion gifts because, while gifts to the trust could qualify for the gift tax annual exclusion if the trust includes Crummey rights of withdrawal, gifts to the trust could not qualify for the GST annual exclusion. (See my November 2009 column.)
Grandmother. Grandmother wants to make additional gifts to the 529 accounts owned by the trust. The tax consequences depend on whether these gifts are annual exclusion gifts or taxable gifts, and possibly on whether the gifts are made to the trust and then transferred by the trustee to the 529 accounts or directly into the 529 accounts owned by the trust. If the trust does not contain Crummey rights of withdrawal, gifts to the trust will not qualify for the gift-tax annual exclusion. Such gifts would be taxable gifts and would either use up a portion of grandmother's $1,000,000 lifetime exclusion or, if she has already used up her lifetime exclusion, would be subject to gift tax. Further, her gifts to the trust will not qualify for the GST annual exclusion. Thus grandmother would have to allocate her GST exemption to her gifts to ensure that future distributions from the Trust to grandchildren were not subject to GST tax.
If grandmother instead makes gifts directly to the 529 accounts owned by the trust, arguably the literal wording of Internal Revenue Code section 529 would qualify such gifts for the gift tax annual exclusion and the GST annual exclusion. Except for the Code section itself, there is no authority on this issue. (Caveat: It is not clear whether gifts made in 2010 to 529 accounts for grandchildren will be protected from GST tax when the funds are distributed to the grandchild. The same problem arises with 2010 gifts to trusts or Uniform Transfers to Minors Act accounts for grandchildren.)
However, even if gifts made directly to 529 accounts owned by the trust did qualify for the gift tax and GST annual exclusion, it is not a good idea to commingle in a single trust gifts that are protected from GST tax by assignment of GST exemption and gifts that qualified for the GST annual exclusion. For GST tax purposes, the trust would be treated as consisting of two portions, the portion over which grandfather is the transferor and the portion over which grandmother is the transferor. The trustee would have to track for accounting purposes how much was in each portion. The portion contributed by grandfather, to which GST exemption was presumably assigned, has a zero inclusion ratio and distributions to grandchildren or more remote descendants would not be subject to GST tax. The portion attributed to grandmother, to which no GST exemption was assigned, does not have a zero inclusion ratio. When a gift qualifies for the GST annual exclusion, it doesn't get a zero inclusion ratio. Rather, the "transferor" is deemed to move down a generation, in this case to the child's generation, so that a future distribution to a grandchild is not subject to GST tax because it is deemed to be a transfer that only passes down one generation, from child to grandchild. However, if a future distribution was made to a great grandchild, GST tax would apply to the portion over which grandmother was considered the transferor because the distribution would be deemed to pass assets down two generations, from child to great grandchild.
If grandmother made gifts directly to the 529 accounts and the gifts did not qualify for the gift tax and GST tax annual exclusions, then the gifts would be taxable gifts and would use a portion of grandmother's $1 million exclusion or, if she had no exclusion left, would be subject to gift tax. If grandmother assigned GST exemption to the gifts, then the portion of the trust attributable to her gifts would also have a zero inclusion ratio. While the GST tax rules would still treat grandfather as the transferor of part of the Trust and grandmother as the transferor of part of the trust, if none of the contributions qualified for the annual exclusion and GST exemption was assigned to all of the contributions it practically would not matter who was the transferor because all trust distributions, whether to grandchildren or more remote descendants, would be protected from GST tax.
The problem is that if grandmother makes gifts directly to the 529 accounts, they may automatically qualify for the annual exclusion. She does not have the option to not claim the exclusion. The only way she could ensure that the annual exclusion did not apply would be to make prior gifts in the same calendar year to the particular grandchild to use fully her annual exclusion.