CNBC’s recent article, “Grandma to the rescue: The $20,000 way to cover preschool,” has a way for baby boomers to share their wealth with their kids and grandkids. They suggest that they pay the expenses of preschool, while eliminating some gift taxes at the same time.
One year of pre-kindergarten at a private elite school can cost thousands of dollars. Generous grandparents can pay these expenses and save on gift taxes. However, this takes some careful planning.
Grandparents can give money to their grandchildren in several ways, without being subject to gift taxes. First, you can make a gift up to the annual gift tax exclusion of $14,000 per recipient (or you and your spouse together can give away up to $28,000). You can also give money away under your lifetime gift tax exemption of $5.49 million, but whatever portion of this amount that you use in “taxable gifts” during your life, will decrease the amount you can pass to your heirs without an estate tax. If you are married, you and your spouse each are entitled to your own lifetime gift tax exemption of $5.49 million. Third, you can pay directly for the grandchild's tuition or medical expenses, even if it is over the annual gift tax exclusion. However, the payments have to go directly to the service provider.
When it comes to preschool, you need to prove to the IRS that your grandchild's pre-kindergarten is educational. To qualify as a nontaxable gift, tuition payments to a preschool must be made to an "educational organization" as defined by the IRS. That means a regularly enrolled student body (no day-care) and the school must also have a regular faculty. A big issue with preschool is that it’s frequently considered custodial care, not educational.
If your grandchild's preschool won’t qualify as an "educational organization," but you still want to help them, consider these alternatives:
- Pay for preschool, but stay under the limit;
- Fund a 529 college-savings plan with a five-year front load, that’s up to $70,000 per beneficiary (the same as $14,000 annually for five years); or
- Provide a low-interest intra-family loan, but talk to an estate planning attorney and draft a formal agreement with your adult child for this option.
Reference: CNBC (March 23, 2017) “Grandma to the rescue: The $20,000 way to cover preschool”