From the Desk of Herb
One of the most commonly asked questions we receive as estate and financial planners is how to make gifts to your children and grandchildren for education or other purposes. In December, everyone is focused on making gifts before year-end.
Some of the most valuable tools for gifting include using items such as IRAs, Roth IRAs, 529 Plans and irrevocable trusts to hold gifts. All of the foregoing can be used for education.
You can make a gift to an IRA that generates an income tax deduction for the recipient of the gift by giving cash to the recipient and allowing the recipient to fund his own IRA. While the gift and subsequent contribution by the recipient to an IRA does not provide you (the donor) with an income tax deduction, it will generate an income tax deduction for the recipient as long as the recipient has earned income. The IRA, to which the recipient of your gift makes a contribution, has an exemption from the early withdrawal penalty if the money is used for qualified higher education expenses. The money withdrawn from the IRA will be subject to income taxes, which is expected since the contribution went into the IRA through a tax deduction. Since there is no income tax deduction for a Roth IRA contribution, both the contribution and earnings come out income tax free. The limit on contributions to IRAs and Roth IRAs in 2017 and 2018 is $5,500.
The limit on making a contribution to a 529 Plan that is not subject to the federal gift tax is generally equal to your gift tax annual exclusion amount of $14,000 in 2017. The annual exclusion amount is increasing to $15,000 for 2018. However, the 529 Plan also allows you to contribute up to five (5) years of annual exclusion gifts in one year. As noted above, the gift tax annual exclusion amount is $14,000 for 2017 and $15,000 for 2018. Therefore, in 2018, the 5-year maximum gift would be $15,000 multiplied by 5, which is equal to $75,000 per donor or $150,000 per couple. This is a great start of a 529 account. Similar to a Roth IRA, the 529 Plan allows the money withdrawn to be taken out with no income tax on the earnings. Under the new tax laws, 529 plans are now much more versatile because distributions may be used for many situations outside of higher education. These contributions are sometimes deductible for state income tax purposes (subject to annual limits), which makes them even more valuable beginning in 2018 when the deduction for state taxes are limited.
Although there are limits to contributions, you can always give more than your annual exclusion by using part of your lifetime exemption of $5,490,000 per person or $10,900,000 per couple in 2017. The proposed tax plan doubles the lifetime exemption. It is best to always use your annual exclusion because it is on a “use it or lose it” basis. Your lifetime exemption is reduced as you use it but it is still better to use it “sooner rather than later” when considering the time value of money and appreciation. There are no gift limitations on your payments directly to a college for tuition and education expenses. Moreover, these gifts do not use up your annual exclusion or your lifetime exemption.
Your next concern is how to make sure the money is used for education and not for a Ferrari. There are no safeguards for the Roth IRA. There will be a 10% penalty for the early withdrawal from the IRA for a Ferrari, but this may not be a real deterrent. The 529 has a custodian on the account to control payments. In place of the custodian, the best safeguard to ensure the intended use of the gift is to make gifts to an irrevocable trust, which has a trustee that controls distributions. An added benefit of the irrevocable trust, is that the trustee can retain the money in trust for the next generation if your child dies before having spent it.
Questions about gift and estate planning? Contact Herb Fineburg at
ABOUT HERB FINEBURG
Mr. Fineburg is recognized as one of Philadelphia’s most respected business lawyers whose substantial knowledge of tax law provides clients with strategic and cost-saving benefits in connection with commercial transactions, taxation and wills, trusts and estates matters. Known for his ability to resolve complicated matters effectively, Mr. Fineburg has assisted businesses and individuals with the organization of their finances, business and real estate affairs, and the structure of their assets (i.e., in LLCs, partnerships, corporations, trusts or joint ownership). He has substantial expertise in the preparation of buy-sell agreements for co-owners who are family members or unrelated business partners and has handled the resolution of shareholder and partner disputes and buy-outs. In addition, to working on bank financings, business contracts and employment matters for his business clients, Mr. Fineburg also provides advice on business acquisitions and sales. Mr. Fineburg, who began his law career as a commercial litigator and bankruptcy lawyer, frequently provides litigation counsel and assistance to a wide range of firm clients. His articles have appeared in the Pennsylvania CPA Journal, the Journal of S Corporation Taxation and other publications. A graduate of Washington University in St. Louis, Mr. Fineburg received his law degree from the University of Missouri and a Master of Laws in Taxation (LL.M) from the New York University School of Law, Graduate Division. Mr. Fineburg is the Managing Shareholder of the Philadelphia office and is also a member of the Board of Directors at Offit Kurman.
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