August 2012 / Volume 10, No. 3


When deciding how to fund the education of a family member or other beneficiary, consideration has to be given to the gift tax and, with respect to grandchildren, generation skipping transfer tax (“GST Tax”) consequences.  This article summarizes some of the tax efficient techniques to fund someone’s education without incurring a tax liability.

Tuition Paid Directly to an Educational Organization.  Any amount paid on behalf of another person as tuition directly to an educational organization for the education or training of the beneficiary will not be treated as a taxable gift.  However, this exemption only covers tuition expenses and not other educational expenses.

Annual Exclusion Gifts.  Currently, gifts of up to $13,000 per individual ($26,000 if a spouse agrees to split the gift) each year can qualify as “Annual Exclusion Gifts”.  Annual Exclusion Gifts are not subject to gift tax and may not be subject to GST tax.  In order to qualify as an Annual Exclusion Gift the gift must be of a present interest.  A gift is considered a present interest if the beneficiary has all immediate rights to the use, possession, and enjoyment of the gift.  There are various ways of making these gifts, or even larger gifts, as described below.

Annual Exclusion Gifts to a 529 Plan.  Under Section 529 of the Internal Revenue Code (“Code”), a program is established and maintained by a state or a private institution.  There are two types of 529 Plans. The first type of 529 Plan allows a person to purchase tuition credits on behalf of a beneficiary at current tuition costs that can be used in the future.  The second type of 529 Plan is a savings plan that allows the donor to make cash contributions to an account that is invested until the funds are withdrawn to pay the beneficiary’s qualified higher education expenses.

Contributions to a 529 Plan grow income tax-free until distributed.  Distributions from a 529 Plan are also income tax-free as long as they are used for the beneficiary’s qualified education expenses (i.e., tuition, fees, books, supplies, and room and board) at an eligible educational institution.  Most colleges, universities, graduate schools and vocational schools will qualify as an eligible education institution.

Gifts to 529 Plans of up to $13,000 ($26,000 for split gifts) qualify as Annual Exclusion Gifts.  A donor can gift up to $65,000 ($130,000 for split gifts) to a child or grandchild in one year, and elect to treat the gift as made over a five calendar-year period.

Annual Exclusion Gifts to a Crummey Trust.  Annual Exclusion Gifts can be made to an irrevocable trust known as a “Crummey Trust” that provides for distributions for the education of the trust beneficiaries.  In order for gifts to qualify as Annual Exclusion Gifts the Crummey Trust must give the beneficiaries the right to withdraw the gifts from the Crummey Trust for a period of time (e.g., 60 days) and the Crummey Trust must require that the beneficiaries be notified of their right to withdraw the Annual Exclusion Gift (these notices are typically referred to as “Crummey Notices”).  The Crummey Trust can be structured so that the Annual Exclusion Gift is also exempt from GST tax.

Annual Exclusion Gifts to 2053(c) Trusts. Gifts of up to $13,000 ($26,000 if split) a year to a trust that meet the requirements of Code Section 2053(c) will qualify as Annual Exclusion Gifts, without requiring Crummey Notices.  Section 2053(c) of the Code requires: (1) the trust to be exclusively for the benefit of one beneficiary under the age of 21; (2) that the trust income and principal may be distributed to the beneficiary before age 21; (3) that the trust estate be distributed to the beneficiary’s estate if the beneficiary dies prior to age 21; and (4) that either all of the trust property be distributed when the beneficiary turns 21 or the beneficiary is provided with a right to withdraw the trust property for a period of time (e.g., 60 days) when the beneficiary reaches the age of 21.  If the beneficiary does not exercise his or her right to withdraw the trust property, the assets can remain in trust.  Annual Exclusion Gifts to 2053(c) Trusts are also exempt from GST tax.

Gift Tax and GST Tax Lifetime Exclusion Gifts.  Gifts in excess of the Annual Exclusion or any gifts that are not otherwise exempt (such as direct tuition payments) are taxable gifts.  In 2012, a person can exclude up to $5,120,000 of lifetime taxable gifts.  Under current law, on January 1, 2013 the lifetime exclusion is scheduled to be reduced to $1,000,000.  Therefore, in 2012 a taxable gift of up to $5,120,000 ($10,240,000 if split with a spouse) can be made to or in trust for the benefit of the beneficiaries without any gift tax being due.  In 2012, there is also a lifetime $5,120,000 GST exclusion.  A beneficial way to use the lifetime gift tax and GST Tax exclusions in 2012 is to make a gift to an irrevocable trust that provides for the education of family members, including future generations.

Conclusion.  With proper planning a person can fund the education of a beneficiary without triggering unwanted gift tax and GST Tax consequences.  There is an opportunity in 2012 to make even larger gifts without generating a transfer tax liability.

By Eileen B. Cozzi


With January 1, 2013 approaching, uncertainty remains as the current $5.12 million estate and gift tax exemption and 35% tax rate may end and be replaced in 2013 with a $1 million exemption and a 55% transfer tax rate.  Accordingly, an opportunity exists this year that may never again exist to transfer a substantial amount of assets to the next generation and avoid potentially larger estate and gift tax rates and lower tax exemptions in the future.  This article will review some of the techniques available to maximize gifting opportunities in 2012. 

Gifting at a Discount – Family Limited Partnerships.  Property having substantial value can be gifted at a discount if the property being transferred is an interest in a family limited partnership or other closely-held business entity.  There are recognized marketability discounts for valuing closely-held business interests and minority interest discounts for non-controlling interests which allow property to be transferred for gift tax purposes at substantially less than its full value.  A substantial gift that is safely within the $5.12 million exemption amount can be effected in 2012 without resulting in the assessment of gift tax.  Properly structured, a 2012 gift can transfer substantial value without necessarily having the donor lose voting control of his or her business or investment property.

Grantor Retained Annuity Trusts and Residence Trusts.  Two leveraged gifting techniques that benefit from today’s low interest rate environment and lower stock and real estate valuations are grantor retained annuity trusts (“GRAT”) and qualified personal residence trusts (“QPRT”).  Under a GRAT, a person transfers an asset to an irrevocable trust in exchange for payments at a fixed rate for a set term.   With a QPRT, a personal residence is transferred to a trust with a retained right to live in the residence for a period of time.  Under either technique, the retained right reduces the value of the gift, and, if the person survives the entire term, the property then passes to the remainder beneficiary (possibly a trust for children) free of future transfer tax.  GRATS are sometimes used with interests in a closely-held business or family limited partnership, so that the value of the property is discounted at the time of the transfer, thereby lowering the annuity paid to the grantor and increasing the value of the transaction.

Sales to Irrevocable Grantor Trusts.  Another gifting technique is to create an irrevocable grantor trust under which the person’s spouse, children or grandchildren will be the income beneficiaries of the trust.  Funds are gifted to the trust for the initial contribution to the trust, then an asset is sold to the trust in exchange for a long-term note.  Since the trust is a “grantor trust” for income tax purposes, there is no taxable gain on the initial sale to the trust, and the income of the trust, though payable to a spouse or children (or other beneficiaries), is taxable to the grantor.  Because the long-term interest rate required under IRS regulations to be charged on a debt instrument is 2.23% for August, 2012, a higher yielding asset can be transferred at favorable rates.

Supercharged Life Insurance Trusts.  Typical irrevocable life insurance trusts have used relatively small annual contributions to fund insurance premium payments, often term insurance.  This year, a large gift can be made to prefund premium payments, using a portion of the current $5.12 million estate and gift tax exemption, and allow a large whole life policy or other form of permanent life insurance policy to be purchased and accumulate earnings on a tax-free basis.  The policy proceeds would eventually pass to the trust beneficiaries tax-free.

Conclusion.  Other gifting techniques include self-cancelling installment notes, charitable remainder trusts coupled with replacement irrevocable life insurance trusts, and low-interest loans.  The current 2012 gift tax exemption amount of $5.12 million may never again exist after this year.  This year likely presents a unique opportunity to make substantial gifts and avoid future estate tax increases.

By Ronald G. Silbert

Schoenberg Finkel Newman & Rosenberg, LLC (312) 648-2300

This newsletter is not intended to be legal or tax advice and is not a substitute for obtaining legal or tax advice. This Newsletter is deemed to be advertising material by the Illinois Supreme Court.