With education costs soaring to all time highs, making tuition payments for grandchildren and others can save a lot of money in gift and estate taxes later on – even when the donor is not alive once the tuition money is obviously used.

By way of some background, the tax laws exempt tuition payments by grandparents or others from any gift taxes, provided certain requirements are met. First, the only real educational costs which can be gift-tax free are tuition costs. The price of room and board, books, and other educational expenses are not exempt.

Second, the tuition costs should be paid straight to an educational organization that “normally maintains a regular faculty and curriculum and normally features a regularly enrolled body of pupils or students in attendance at where its educational activities are regularly carried on.” Notice that there’s no requirement that the tuition costs be paid to a college or university. In fact, tuition payments for nursery school, private elementary school, and private high school might also qualify. It’s possible, too, that tuition payments for part-time courses, such as for instance dance, theater, music, cullinary arts, and such will also qualify for the gift tax exemption.

So, how is this such much? In the very first place, these tuition payments are not treated as taxable gifts, which means you don’t have to worry about having them come underneath the annual gift tax exclusion. tutors online math  In fact, you may make tuition payments for the grandchildren or others and still give each of them the annual exclusion amount ($12,000 for 2006) as a birthday gift or whatever.

Second, if your estate is large enough to take into account federal estate taxes (currently in excess of $2 million, $4 million for a couple), then the total amount of the tuition payments will be excluded from your estate upon your death. In other words, your tuition payments won’t be susceptible to a gift tax once the payments are manufactured, nor will they be susceptible to an estate tax upon your death. Additionally, they’ll not be susceptible to any generation-skipping taxes (GST) upon your death

That’s very good deal by itself, but here’s an additional bonus. On July 9, 1999, the Internal Revenue Service issued Technical Advice Memorandum 199941013 stating that prepayment of tuition costs was also exempt from gift taxes under IRC Section 2503(3)(2). In that particular case, a set of grandparents had made payments to a personal school to cover tuitiion costs for his or her two grandchildren from pre-school through grade 12. There clearly was an agreement between the school and the grandparents indicating that the tuition payments would not be refundable even when the grandchildren failed to wait the school each of the years. The total payments made by the grandparents amounted to over $181,000 over a two-year period.

Recently, the Internal Revenue Service issued a personal letter ruling that supports the Technical Advice Memorandum cited above. In that case, the IRS told a taxpayer that prepayments of several years of tuition costs for his grandchildren would not certainly be a gift.

While Technical Advice Memorandums and private letter rulings only apply to the taxpayer’s who request them, they’re a great indication of the IRS’ position on specific tax matters. Here, it seems fairly clear that prepayment of multiple years of tuition costs won’t be treated as a taxable gift by the IRS.

Now, let’s type of put all this into perspective. In the TAM discussed above, the grandparents pre-paid roughly $181,000 of tuition costs over a two-year period. The payments weren’t treated as taxable gifts and, since the amount of money was removed from their estate, it wasn’t susceptible to estate taxes upon their death. If the grandparents kept the amount of money until they died and then gave it with their grandchildren under their will, it might have gone through probate first, then could have been susceptible to a federal estate tax and then, possibly, a generation-skipping tax – all before it could be utilized by the grandchildren.

If the grandparents had a reasonably large estate, say larger than $4 million, then your estate taxes paid on that $181,000 will be roughly $83,260 (based upon a marginal tax rate of 46%). In that case, prepaying the tuition costs resulted within an estate tax savings of roughly $83,260. Plus, the grandparents didn’t have to use up their annual gift-tax exclusion to have the estate tax savings.