Qualified tuition plans (QTP) provide a means for family members and others to save for the future educational needs of children. Investment earnings within a QTP account are tax deferred and not taxable when withdrawn if used to pay for qualified tuition and expenses.
Each individual’s contribution to a QTP (also referred to as a “Section 529 plan”) on behalf of a designated beneficiary is treated as a gift subject to the normal gift tax rules. Thus, no gift tax return is required for any contributor if the contribution is equal to or less than the contribution year’s gift tax annual exclusion, which for 2019 is $15,000.
Special Election – When a donor’s total contribution to a QTP for the year exceeds the annual exclusion amount, the donor may make a special election treating the contributed funds as if they had been contributed ratably over a five-year period starting with the year of the contribution.
Example: Grandpa Lee contributes $75,000 to granddaughter Whitney’s QTP in 2019. By using the election grandpa’s contribution is treated as if the contribution was made ratably over a five-year period, i.e., treated as if he’d contributed $15,000 in each of 2019, 2020, 2021, 2022 and 2023. If grandpa makes any more QTP contributions during those years, those contributions would then exceed the annul gift limit and require a gift tax return to be filed. The same would be true if grandpa makes other gifts to Whitney.
To make the five-year election grandpa must file a Form 709, Federal Gift Tax Return, for the calendar year in which the contribution is made.
The election is available only with respect to contributions not in excess of five times the annual exclusion amount for the calendar year of the contribution. Any excess is treated as a taxable gift in the calendar year of the contribution. However, that does not necessarily mean any gift tax will be owed since the unified gift and estate tax lifetime exclusion (currently in excess of $11 million) will shield most taxpayers like grandpa from any gift tax.
If grandpa were married, he and grandma could make an election under the gift-splitting rules for the QTP contribution to be made one-half by each of them, thus allowing them to double up on the annual and the special 5-year amounts.
If in any year after the first year of the five-year period, the amount of the gift tax annual exclusion is increased for inflation, the donor may make an additional contribution in any one or more of the four remaining years up to the difference between the exclusion amount as increased and the original exclusion amount for the year or years in which the original contribution was made.
Example: In 2017 when the annual gift tax exemption was $14,000, grandpa made a $70,000 contribution to his granddaughter’s QTP and made the 5-year election. In 2018 the annual gift tax exemption was increased to $15,000. Thus, grandpa can make an additional $1,000 contribution for each of the remaining 4 years of the 5-year election period.
Change of Beneficiary – A change in the designated beneficiary, or a rollover to the account of a new beneficiary, is treated as a taxable gift if the new beneficiary is assigned to a generation below the generation of the old beneficiary. Such a transfer isn't a taxable gift if the new beneficiary is a member of the family of the old beneficiary, and is assigned to the same generation, as the old beneficiary. (Code Sec. 2651)
If the new beneficiary is assigned to a lower generation than the old beneficiary, the transfer is a taxable gift from the old beneficiary to the new beneficiary, regardless of whether the new beneficiary is a member of the family of the old beneficiary.
In addition, the transfer would be subject to the generation skipping transfer tax (GST) if the new beneficiary is assigned to a generation which is two or more levels lower than the generation assignment of the old beneficiary. The five-year averaging election may be applied to a transfer. (Code Sec. 529(c)(2)(B))
Example: Suppose Whitney had not used the funds from the QTP or finished her higher education and had some funds left over in the plan, and grandpa (or the trustee of the account if grandpa is not the trustee) decides to change the account beneficiary to his great- granddaughter Annabelle. Since Annabelle is in a generation lower than Whitney, the change of beneficiary represents a gift from Whitney to Annabelle. However, the five-year averaging election may be applied to the gift.
Direct Payment of Tuition – Some potential contributors to a QTP for family members may wish to pay for the tuition when it is actually incurred rather than saving for it in advance. If that individual makes the tuition payment directly to a qualified school, college or university the gift tax does not apply. (Code Sec. 2503(e))