Tuition Gift Tax Exclusion

on April 13, 2017

Tuition Gift Tax Exclusion

Amount

Direct payments to

a college or university

Eligible Expenses

Tuition

Eligible Students

No restrictions

Number of Years

Unlimited

Income Phase-outs

None

 

Direct payments of tuition to a college or university do not incur gift taxes. This tuition gift tax exclusion is in addition to the annual gift tax exclusion amount.

 

The gift tax exclusion is for payments of tuition made directly to an educational institution. Indirect payments to a trust are not eligible, even if the trust is limited to making payments of tuition.

 

The tuition gift tax exclusion does not cover fees, just tuition, as the statutory language mentions only tuition. Other college costs, such as room and board, books, supplies and equipment, also are not eligible.

 

There are no enrollment status restrictions, so students can be enrolled part-time, even less than half-time. The tuition gift tax exclusion may also be used for unaccredited colleges, foreign universities and colleges that are not eligible for Title IV federal student aid. The donor and recipient do not need to be related to each other.

 

There are no income phase-outs and the gift tax exclusion does not expire.

 

Impact on Eligibility for Need-Based Financial Aid

 

Using the tuition gift tax exclusion reduces the student’s eligibility for need-based financial aid. In most cases, it is better to contribute the money to a student- or parent-owned 529 college savings plan if the student is a dependent student. 529 college savings plans provide a five-year gift tax averaging option, which is sufficient for most families, and offer more favorable financial aid treatment.

A direct payment of tuition to a college or university normally is treated as cash support, which gets reported as untaxed income to the student on a subsequent year’s Free Application for Federal Student Aid (FAFSA). Cash support includes money and gifts for college costs and money paid to someone else on behalf of the student. Untaxed income reduces eligibility for need-based financial aid by as much as half of the gift amount.

 

If the payment is made by a dependent student’s custodial parent, however, it does not have any impact on the student’s eligibility for need-based financial aid. Such payments are excluded from the definition of cash support, due to an intentional loophole enacted by Congress at 20 USC 1087vv(b)(1)(F). However, payments by a dependent student’s non-custodial parent, grandparents, aunts, uncles and other third parties do count as cash support.

 

Some colleges may incorrectly treat a direct payment of tuition as a resource, which reduces current eligibility for need-based aid dollar-for-dollar.

 

Regardless of whether a direct payment of tuition is treated as cash support or a resource, it has a harsh impact on aid eligibility.

 

There are a few workarounds, besides contributing the money to a 529 college savings plan. One involves waiting until Jan. 1 of the sophomore year in college to make the direct payment, when no subsequent year’s FAFSA will be affected by the cash support. (This workaround considers the use of a prior-prior base year on the FAFSA.)

 

Another workaround involves giving the money to the parents. Although this doesn’t avoid the gift tax implications, it does avoid the negative impact of cash support on eligibility for need-based aid since gifts to the parent do not get reported as income on the FAFSA. Nevertheless, gifts to the parents do count as assets if they remain unspent by the time the FAFSA is filed. So, timing of the gift to the parents matters and should ideally occur just before the college bills are due and/or after the FAFSA is filed.

 

Coordination Restrictions

 

Contributions to 529 college savings plans are not eligible for the tuition gift tax exclusion, as they are not direct payments to tuition to an educational institution. Direct payments of tuition can qualify for both the tuition gift tax exclusion and for the American Opportunity Tax Credit, Lifetime Learning Tax Credit or Tuition and Fees Deduction because there are no coordination restrictions that prevent double-dipping in this manner.

 

Direct payments of tuition on behalf of a specific student do not qualify as a charitable contribution.

 

Additional Information

 

The statutory language appears in the Internal Revenue Code at 26 USC 2503(e). The current regulations can be found at 26 CFR 25.2503-6.

 

The statutory language provides for a gift tax “exclusion for certain transfers for educational expenses … paid on behalf of an individual … as tuition to an educational organization described in section 170(b)(1)(A)(ii) for the education or training of such individual.”

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