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Caveats Remain on Trust-Owned 529s

Plus, get answers on disability early-withdrawal penalty exemptions, 529 bankruptcy protections, and more.

Susan T. Bart, 01/25/2013

1. I read your article dated Nov. 19, 2003, and found it to be very thorough and extremely helpful. One statement, though, left me a bit confused. In the “Disadvantages” section of the article, you stated that "it may be possible for a donor to directly make a contribution to a 529 savings account owned by the trust and make the five year election." This was regarding frontloading five years' worth of annual exclusion gifts to a 529 plan. Could you please clarify under what circumstances it would not be possible?

The article "How to Make a Trust an Account Owner of a 529 Plan" included the following comment:

Trust-owned 529 savings accounts can have the following disadvantages:

1. No Frontloading of Trust Distributions. While a trust could invest any amount of assets already in the trust in a 529 savings account (subject to state contribution limits and fiduciary duties) without gift tax, for a new trust the donor has to fund the trust before the trust can invest in the 529 savings account. With an individually owned 529 savings account, the donor can contribute five times the annual exclusion amount to the account in one year and elect to treat the gift as if it were made over five years. This five-year election is only available for gifts to 529 savings accounts and is not available for gifts to trusts. However, it may be possible for a donor to directly make a contribution to a 529 savings account owned by the trust and make the five-year election.

It's now 2013, almost 15 years after the proposed regulations to Internal Revenue Code section 529 were issued in 1998, and nine years after I wrote the 2003 article, and we have no more guidance than we did then on trust-owned 529 accounts. The IRS did suggest in its 2008 Advance Notice of Proposed Rulemaking that perhaps it simply wouldn't allow trusts to be account owners, but it hasn't acted on that proposal yet.

Code section 529(c)(2)(A) says that any "contribution to a qualified tuition program on behalf of any designated beneficiary . . . shall be treated as a completed gift to such beneficiary which is not a future interest in property." As a completed gift to the beneficiary (and not to the account owner) that is not a gift of a future interest, a gift directly to a trust-owned 529 account should qualify for the gift tax annual exclusion regardless of whether a gift to the trust would have qualified for the gift tax annual exclusion. Code section 529(c)(2)(B) then states that if "the aggregate amount of contributions described in subparagraph (A) during the calendar year by a donor exceeds the limitation for such year under section 2503(b) [the gift tax annual exclusion], such aggregate amount shall, at the election of the donor, be taken into account for purposes of such section ratably over the five-year period beginning with such calendar year."

It seems to me that the most reasonable reading of that provision is that if you make a contribution to a 529 account that exceeds the amount of the gift tax annual exclusion you can make the five year election, regardless of who is the account owner.

I qualified my statement in the 2003 article only because we have no guidance on the treatment of contributions to trust-owned 529 accounts. The IRS might try to argue that you have to treat a contribution to a trust-owned 529 account first as a contribution to the trust and then as an investment by the trust in the 529 account. Under such a construction, the contribution may or may not qualify for the gift tax annual exclusion, depending upon the terms of the trust, and would not qualify for the five-year election. I think such a construction would be contrary to the clear language of Code section 529, but absent any regulations or rulings on this issue, I still feel a need to put a caveat on my answer.

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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