Tax client questions and considerations

¶ … functioned by a state or educational organization, like a college, with tax compensations and hypothetically other inducements to make it cooler to save for college and other post-ancillary training for a selected beneficiary, such as a juvenile, daughter/son, or grandchild (Feigenbaum 2002, pg. 34). 529 plans apart from secondary benefits, have a main advantage linked to earnings.

The earnings of a person enrolled in a 529 plan are not subject to federal tax and normally not subject to state tax when used for the qualified education expenditures of the selected beneficiary. These expenditures would typically include: tuition, books, fees, books, even room and board. There are some things that are not deductible in a 529 plan, one such are contributions. Additionally, it is important to keep in mind that the IRS, from time to time, will update or modify their tax laws.

Since 2009 or 2010, a qualified, nontaxable distribution from a 529 plan now contains the fee of the buying of any computer equipment, linked technology and/or linked services like Internet access. "The technology, equipment or services qualify if they are used by the beneficiary of the plan and the beneficiary's family during any of the years the beneficiary is enrolled at an eligible educational institution" (IRS). This is important to note if one wants to use gift money to buy the beneficiary a computer to minimize taxes and still give the amount of money desired to the beneficiary. Keep in mind that computer equipment only qualifies if it suits an educational purpose. Gaming platforms like Xbox are not considered computer equipment. The computer equipment and technology is only applicable to 529 plan withdrawals.

A quick background on the origins of the 529 plan reveal it was made by Congress in 1996 and was named after section 529 of the IR code (Ameriprise). Even though many people including the IRS refer to the program as the 529 plan, its legal name is: "Qualified tuition program." Even though the plan does not have any restrictions on income and the number of plans one can set up, there are limits to contributions before they begin to get taxed. This is where the issue of $30,000 contribution comes into play.

Contributions may not surpass the amount required to provide for the qualified education expenses of the recipient. This means that if the contributor of the plan exceeds the annual limit of $14,000, there may be gift tax penalties. This limit also applies to any other gifts, to an individual recipient. So, if one contributes $30,000 to a child's 529 plan in any given year, for instance, one could generally apply this gift against one's $14,000 annual gift tax exclusion. This means that while the entire $30,000 gift must be reported on a federal gift tax return, it would show that only $16,000 is taxable. One must use up the federal applicable exclusion amount which was $5,250,000 in 2013, before having to write a check for the gift tax (IRS).

There is also a special rule for those who contribute over $14,000 in a single year. Section 529 plans proposition a distinctive gifting feature. Explicitly, one can make a lump-sum contribution to a 529 plan of a maximum of $70,000, choose to spread out the monetary gift regularly over a time frame of five years, and entirely circumvent federal gift tax, if no other gifts are completed to the same recipient during the five-year period. Married couples have their maximum increased to $140,000. For instance, contributions made in the amount of $70,000 to a child's 529 account in one year will be seen as if $14,000 gift were made each year during a five-year period if the person elects this option. Grandparents have different rules applied to them but since the scenario includes a parent to child contribution, this would not apply.

Since states offer different 529 plans, it's beneficial to look at competitors and see which plan is best. Additionally, if a parent does wants to change the amount gifted to a child and transfer it to another child, he/she can do so without fear of penalty creating a possible scenario where the parent can give $15,000 to two children for a total of $30,000 and only play gift taxes on $2,000.

If the parent decides to choose the lump sum, 5-year option, for each of the five years, the parent must report in Part 1 of Schedule A one-fifth or 20% of the amount for which the election was made. "In column E. Of Part 1 (Schedule A) list the date of the gift as the calendar year for which you are deemed to have made the gift (that is, the year of the current Form 709 you are filing). Do not list the actual year of contribution for subsequent years" (IRS, "Instructions for Form 709 (2013)"). This only applies if contributions are made after the initial year. If no contribution are made after the initial year and are not made during the subsequent four years, than filling out a Form 709 will not be required.

A good way to explain this scenario would be through an example:

In 2013, Doug contributed $30,000 to a QTP for the benefit of his son. Doug elects to treat all of this contribution as having been made ratably over a 5-year period because he knows he will not be making any more gifts and even if he does, as long as it does not exceed $70,000 it will not be taxed. Therefore, for 2013, Doug reports the following:

$0 (the amount of the contribution that exceeded $70,000)

+ $6,000 (the 1/5 portion from the election)

$6,000 the total gift to his son listed in Part 1 of Schedule A for 2013

In 2014, Doug gives a gift of $8,000 cash to his son and no other gifts. On his 2014 Form 709, Doug reports in Part 1 of Schedule A the $8,000 gift. The gift to his son would be regarded as $0 in terms of taxable gifts because the 20% or $6,000 from the initial contribution of $30,000 made it so for the 5-year period he would list only $6,000 per year. Since the limit is $14,000 on annual gifts, he can still give up to $8,000 annually to his child and not have the amount taxed because $8,000 + $6,000= $14,000. In column E. Of Part 1 (Schedule A), Doug inputs "2014" as the date of the contribution. Doug then makes no gifts for the following three years: 2015, 2016, or 2017. Therefore, he is not required to file Form 709 as explained previously.