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Gifts and 529s

Here's a quick review of the gift-tax reporting rules.

Susan T. Bart, 04/23/2010

College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to advisorquest@morningstar.com.

This an appropriate time to review the gift tax reporting rules for gifts to 529 college savings accounts.

Gifts Under Gift Tax Annual Exclusion
If a taxpayer's gifts to a particular individual during the calendar year, including any contributions to 529 accounts with such individual as the designated beneficiary, all qualify for the gift tax annual exclusion (and, in the case of a donee who is two or more generations below the donor, the generation-skipping transfer tax annual exclusion) and do not exceed the $13,000 gift tax annual exclusion, no gift tax reporting is required. Outright gifts to individuals, gifts to Uniform Transfers to Minors Act accounts and gifts to 529 accounts all qualify for the gift tax annual exclusion. Gifts to trusts may or may not qualify for the gift tax annual exclusion depending upon whether the trust gives the beneficiary a "present interest."

In the case of gifts to grandchildren or more remote descendants (or to certain nonfamily members who are more than 37 ½ years younger than the taxpayer), the taxpayer's gifts to the individual during the calendar year must also qualify for the GST annual exclusion to avoid reporting requirements. Outright gifts to individuals, gifts to Uniform Transfers to Minors Act accounts and gifts to 529 accounts all qualify for the GST annual exclusion. Gifts to trusts may or may not qualify for the GST tax annual exclusion; however, the rules for qualifying for the GST annual exclusion are more stringent than the rules for the gift tax annual exclusion. Therefore, a gift to a trust could qualify for the gift tax annual exclusion but not the GST annual exclusion.

Gifts Under Gift Tax Annual Exclusion After Split Gift Election
If a married taxpayer's gifts to a particular individual during the calendar year, including any contributions to 529 accounts with such individual as the designated beneficiary, all qualify for the gift tax annual exclusion and, if applicable, the GST annual exclusion, but exceed the $13,000 gift tax annual exclusion, if the combined gifts of the taxpayer and the taxpayer's spouse do not exceed twice the annual exclusion amount ($26,000 for 2009 and 2010) and all qualify for the gift tax annual exclusion and, if applicable, the GST annual exclusion, then a taxable gift can be avoided if the spouses make a split gift election under which they each agree to be treated as if they had made one-half of the gifts made by the other spouse. The taxpayer, however, must file a gift tax return and the spouse must sign the gift tax return to make the split gift election even though, after the election, there will be a taxable gift. Under some circumstances the spouse also will be required to file a gift tax return.

Gifts Over Gift Tax Annual Exclusion
If a taxpayer's gifts to a particular individual during the calendar year, including any contributions to 529 accounts with such individual as the designated beneficiary and after applying the split gift election if such an election is made, exceed the $13,000 gift tax annual exclusion, the taxpayer is required to file a gift tax return. Ordinarily the gifts to such individual in excess of the gift tax annual exclusion will be treated as taxable gifts. (But see the discussion below of the five-year election.) The amount of the taxable gifts will either decrease the amount of the taxpayer's $1,000,000 lifetime exclusion, or if such lifetime exclusion is exhausted, will be subject to gift tax.

In the case of gifts to an individual two or more generations below the taxpayer (e.g. a grandchild), the gifts to such individual in excess of the $13,000 GST annual exclusion will be GST transfers. The taxpayer may apply a portion of the taxpayer's $3,500,000 (in 2009) GST exemption to the gift to avoid gift tax (or in some cases the tax rules automatically allocate GST exemption to the gift unless the taxpayer elects out of automatic allocation). If the taxpayer (or the tax rules) does not allocate GST exemption to the GST transfer, the taxpayer will owe GST tax on the gift, in addition to any gift tax due on the gift.

The Five-Year Election
With respect to any gifts to a 529 account, if the taxpayer's contribution to the account (after applying any split gift election) exceeds the amount of the gift tax annual exclusion, the taxpayer may elect to treat the gift as if it were made pro rate over the five-year period beginning with the year of the gift. The election cannot be made if the contribution to the 529 account is less than the gift tax annual exclusion, even if the taxpayer's aggregate gifts to the beneficiary during the year exceed the gift tax annual exclusion. The taxpayer does not have the option to prorate the gift over a lesser number of years or to allocate different amounts of the gift to different years. For example, if the taxpayer contributes $25,000 in 2009 and makes the election, the taxpayer will be treated as making a $5,000 annual exclusion gift in each of years 2009-2013. The donor cannot elect to treat the gift as if it were a gift of $13,000 in 2009 and a gift of $12,000 in 2010.

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