If grandparents will be helping with college tuition, there may be gift tax implications.
Many students and families have several methods to help pay for college: grants, scholarships, student loans, college savings plans, and personal gifts. Monetary gifts to help pay for college, especially from grandparents or other family members, sound great at first. Who wouldn’t want a gift of money for college, no strings attached?
Note, though, that depending on the size of the gift and the method of payment, there may be tax implications and/or an impact on financial aid awards. If you’re planning to have grandparents help pay for college, here’s what you need to know.
Note: The following tax information is relevant as of spring 2018 and intended for informational purposes only. If you have questions about your specific circumstances, such as eligibility for a specific tax deduction, consult a licensed tax professional.
Contribute to a 529 Plan
529 plans, established in the mid-90s, are tax-advantage savings vehicles that enable families to put money away for future college expenses. While many parents have established 529 plans on behalf of their children, they’re not necessarily the only contributors: Many grandparents and relatives often contribute.
When grandparents want to put money in their grandchild’s 529 college fund, they may not necessarily be able to do so directly. Look at the regulations regarding 529 contributions for the specific account: In some cases, grandparents may be able to deposit money directly to the account on behalf of the benefited student; in other cases, only the account holder may make deposits. Additionally, depending on residency status, in-state contributors to qualifying 529 plans may also be able to request a state tax deduction or credit.
In 2018, individuals can give up to $15,000 to another person and not be subject to the gift tax. And if you put the monetary gift into a 529 plan for use as qualified education expenses, the money won’t be taxed as income for the grandchild or subject to withdrawal penalties. (That point is moot, however, if the money is used for non-qualifying expenses or withdrawn early.) So if each grandparent makes a maximum individual contribution, that’s a potential $60,000 untaxed gift (from four grandparents) to go toward college.
Additionally, grandparents can now make larger one-time contributions to 529 plans, spread out over five years, to take advantage of new tax breaks. Speak with a CPA or licensed tax professional to see if this option makes sense for your specific circumstances.
Pay Tuition Directly to a College or University
Grandparents can also elect to write a check directly to their grandchild’s college or university to cover tuition--and as long as the check is paid directly to the school, no gift tax will be incurred.
Paying the college directly also enables grandparents to make a secondary gift to their grandchild, in the same year, without being subject to gift taxes. Under this scenario, let’s say granddaughter Madison is a freshman at UCLA and needs help paying for college. The grandparents can write a $15,000 check payable to UCLA, and a $15,000 check directly to Madison, without tax penalties.
When a grandparent writes a check, however, it gets reported on the FAFSA as untaxed income—which will impact financial aid awards. Speaking to the Wall Street Journal, Mark Kantrowitz of Edvisors.com says, “a direct payment to a college by anybody other than the student’s custodial parent or parents will count as cash support. This can have a severe negative impact on eligibility for need-based financial aid.” So if you’re planning to have grandparents pay for tuition, it may result in less need-based money from the federal government and/or the college itself.
Let’s not forget about giving cash for college, as many a grandparent takes the tried-and-true route of slipping cash or a check in the graduation card. Modest amounts (e.g., a few hundred dollars) won’t be an issue, but if the plan is to make a substantial cash gift, be aware of potential penalties (see the gift tax limits and FAFSA impacts we’ve already discussed). Additionally, there may be generation-skipping transfer (GST) tax consequences, where taxes are levied for gifts made to individuals more than one generation below the gifter.
To avoid issues with cash gifts to help pay for college, grandparents can gift cash to parents instead of grandchildren, as gifts to parents don’t need to be reported as income on the FAFSA, according to Mariner Wealth Advisors, a Kansas-based advisory firm. Alternatively, grandparents can withhold cash gifts until their grandchild graduates from college, and then use the gift toward student loan payments.
If you’re planning to use gifts from grandparents to help cover the cost of college, make sure everyone is well aware of all financial considerations before accepting. You’ll want to maximize the monetary value of each gift, while minimizing all potential tax and financial aid award penalties.