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529 Contributions and the Five-Year Election

Questions on allocating 529 contributions and gift tax liabilities over the five-year period.

Susan T. Bart, 09/23/2011

1. RIA's 706/709 Deskbook contains the following observation:

The proposed regulations state that a donor may take certain contributions to a QTP into account ratably over five years only with respect to contributions not in excess of five times the annual exclusion amount [Prop. Reg. 1.529-5(b)(2)]. The authors believe that this provision would permit the following, although guidance is not clear.

Example 25D-5: Excess QTP contribution-election of amount less than $65,000.

Taxpayer contributes $33,000 to a QTP in Year 1 and elects to treat $25,000 as a prorated contribution over five years. (Assume a $13,000 annual exclusion for all five years.) Thus, in Year 1, taxpayer utilizes the annual exclusion amount with an $8,000 (non-prorated) contribution and $5,000 from the amount subject to the election to prorate. In Years 2 through 5, the taxpayer is electing to treat as a prorated contribution $5,000 per year.

I believe that the statute specifically requires that the entire $33,000 contribution in RIA's example be allocated over the five-year period. Have you focused on this issue?

The statement quoted above is in RIA's PPC Federal Tax Compliance Library, the 706/709 Deskbook, Chapter 25, Key Issue 25D.

First, why does the taxpayer in the above example want to make the election over only $25,000 and not $33,000? Because the taxpayer wants to use fully his or her annual exclusion for Year 1, and by doing so reduces the amount of annual exclusion deemed to be used for Years 2 through 5 from $6,600 per year ($33,000 ÷ 5) to $5,000 ($25,000 ÷ 5). Thus the taxpayer can make greater additional annual exclusion gifts in Years 2 through 5.

I read the statute as requiring the entire contribution to the 529 account to be subject to the five-year election, if such election is made. I read the proposed regulations as trying to modify this rule only to provide that if the aggregate contributions exceed five times the annual exclusion amount, the excess must be treated as a taxable gift all in Year 1 and cannot be spread out over five years.

Susan T. Bart is a partner in the Private Clients, Trusts & Estates Group at Sidley Austin LLP in its Chicago office, where her practice includes estate planning, estate and trust administration, and fiduciary counsel. She has written two books, including Education Planning and Gifts to Minors published by Illinois Institute for Continuing Legal Education (iicle.com), which extensively discusses 529 plans.

She is the author of Education Planning and Gifts to Minors 2004 Edition. She is a frequent speaker on trust and estate topics in general and Section 529 college savings plans in particular.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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