When it comes to student finances, it's not as simple as giving money to a loved one toward their education and moving on your merry way. If you intend to financially contribute to a student's higher education, it's important to understand the potential consequences of that gift.
The Internal Revenue Service has a lot of rules and regulations. When you gift money toward education, there is a tax to be considered. The tax is most commonly referred to as a Gift Tax. There is also a related tax called the Generation-Skipping Transfer Tax, or GSTT. While none of this may sound like good news, there is some good that can be done regarding your generous gift:
Understand the Transfer Taxes. The transfer tax refers to the percentage the federal government will take when one person gives money to another. This money can include an inheritance received upon one's death. It is important to have an understanding of how these taxes work, because many people will make mistakes in calculating such taxes and can end up with a costly error to fix.
For starters, consider the funding of a college account when a child is still very young. Each year the child can receive tax-free gifts for his or her account up to a certain amount known as the annual exclusion amount. The total amount of money you can gift will vary from year to year based on inflation. You can gift these funds through several financial resources including a trust, a 529 savings plan, or other accounts for educational purposes. You can gift cash, stocks and bonds, or anything else of value, which will be deducted from the annual exclusion amount.
If you go over the allowable amount with your gift, the remaining amount will be subject to the IRS gift tax regulations. However, like many governmental regulations, there are exceptions to the rule. For instance, with Section 529 college savings plans, fund amounts can be deposited without gift taxes coming into play. These accounts can allow you to add extra monies as your child gets closer to graduation. The Section 529 plan allows up to five years' worth of gifts per the annual exclusion amount to be given in one year.
Figure Out GSTT. When it comes to the GSTT, the government allows one generation to gift money to a subsequent generation. For example, when grandparents gift to their grandkids, they skip over their own children in the process. The GSTT is calculated by the amount of money that would have been collected through government taxes had the money first went to the children and then transferred to the grandchildren. This tax was developed for those who are well-off financially, allowing $2 million per donor annually, with amounts changed as dictated by inflation.
Educational Expense Considerations. If you are planning to pay your child's tuition directly to the school facility, don't be concerned with gift taxes. This payment method will also not affect your annual inclusion amount if you still plan to give financial gifts to others. However, if the student is going need financial aid for tuition assistance, your payments will be considered untaxed income on the student's following year's application for FAFSA.
Seek Professional Advice. There is a lot of information and exceptions to the rules of the IRS when it comes to financial gifts for students and tax implications. If you are considering your best plan of action for giving financial gifts to students to help cover college expenses, it may be wise to seek the assistance of a qualified financial advisor, who can explain the specific ramifications of your gift amounts where taxes are concerned. While it would be great to just give a bundle of cash to your loved ones, the government doesn't see it that way. There are many considerations to make concerning financial gifts and educational savings, and it is advisable to seek the counsel of a qualified financial advisor to prevent costly mistakes in your personal finances.
If your children are still young, it is also wise to get serious about saving for college, even if those years seem far off. The earlier you start saving toward a college education, the less you will need to struggle when high school graduation is on the horizon.
Debbie Dragon is a contributor to MyBankTracker.com, where she writes about personal finance, taxes, and banking.
- Financial Aid