There are distinct benefits to grandparents paying for early education for their grandchildren. Most nanas and pop-pops have probably heard about the benefits of funding a 529 account. This type of account helps pay off those formidable education costs by allowing their issue’s issue to draw from it tax-free to pay for tuition, books, supplies, and fees at a variety of colleges, universities, and vocational and trade schools.
But the bills for private preschools and elementary schools can be scary, too. It’s especially true in some of the nation’s larger cities, where fees can exceed those of in-state colleges. In New York City, for example, some of the more exclusive primary schools can cost more than $30,000 a year. Parents can use up to $10,000 for tuition only at private, public, or religious elementary and secondary schools with a 529 account.
The Tax Cuts and Jobs Act of 2017 along with the Setting Every Community Up for Retirement Enhancement Act, also known as the SECURE Act, which was signed into law on Dec. 20, 2019, both expanded 529 plan qualified expenses. However, 529 plan funds cannot be used for preschool and daycare services.
- There are tax-advantaged ways for grandparents to help their grandkids out with education expenses, even preschool.
- These techniques help out your children with expenses and help your family overall by reducing the size of your estate, therefore limiting the likelihood of ever being charged an estate tax.
- You can take advantage of the gift tax exemption, in which gifts of up to $16,000 for 2022 ($17,000 for 2023) can be made without the amount of the gift having to be added to your lifetime estate and gift tax limits.
- You can also avoid the gift tax issue altogether by paying the education costs directly to the program; no taxes are due when payment is for qualified education expenses.
- You can also start a Coverdell Education Savings Account (ESA) for your grandchild, although the donation limits are fairly low and your income cannot exceed specified levels.
The Benefits of Paying
Thankfully, the Internal Revenue Service (IRS) offers some nice incentives for grandparents who want to help with early education. Taking advantage of these provisions can stretch each dollar you spend, not to mention shield your assets from the taxman when your estate gets passed along to your heirs.
Fast Fact: A special IRS rule allows givers to spread their one-time gifts across five years worth of gift-tax exemptions, without the money being counted toward the lifetime estate and gift tax limit; meaning, a grandparent can pay $80,000 in one year and count it as having been paid over five years ($16,000 x 5 years).
Calculation of an Exchange Rate
An exchange rate is the value of one country’s currency in relation to another currency.
For example, if the USDCHF exchange rate is 1.15, it means that 1 Swiss Franc is worth 1.15 US Dollars.
Exchange rates fluctuate based on economic factors such as inflation, interest rates, and geopolitical events. These factors will increase or decrease the supply and demand for a particular country’s currency and thus influence the exchange rate.
The Gift-Tax Exemption
Ordinarily, a taxpayer can only confer $16,000 a year for 2022 ($17,000 for 2023) to each grandchild (or anyone else, for that matter) without triggering the gift tax. The limit is per person, meaning a couple can give $32,000 for 2022 ($34,000 for 2023) per year to each grandchild.
Granted, the gift tax doesn’t have to be paid immediately, and in some cases, it doesn’t have to be paid ever. The amount of money gifted that surpasses the $16,000 limit for 2022 ($17,000 for 2023) is counted toward the lifetime exemption from gift and estate taxes. In 2022, the exemption is $12.06 million ($12.92 million for 2023).
That limit, however, doesn’t apply if you pay your grandchild’s school directly to cover tuition fees. This “education exemption” is a great way for individuals to contribute toward those steep private-education costs.
For older adults with extensive assets, it’s an excellent estate-planning tool, as well. Any money you give to your grandkids now helps reduce the size of your estate for tax purposes. That can make a difference for the wealthiest Americans, given that the government takes up to 40% of any estate larger than $12.06 million for 2022 ($12.02 million for 2023). Even though your heirs don’t pay the taxes directly, you’re doing them a huge favor by staying under that threshold.
Important: The preschool your grandchildren attend must be more of an educational facility than just a childcare center if you want to be able to pay the costs tax-free, as per IRS rules.
The Preschool Factor
In theory, grandparents can use the education exemption to cover preschool bills, too. But this is where things get a little dicey. If the preschool is more of a childcare facility than an educational institution, you’re out of luck. According to the IRS Form 709: “A qualifying educational organization is one that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.”
So if you plan to pay tuition in a high-cost part of the country, make sure to find a school that fits the criteria. It’s also important to keep in mind that the exemption only works for qualified tuition costs. It won’t apply to ancillary expenses, such as books and supplies.
If the child enrolls in a school that requires a contract, experts caution that the person paying the bill—even if it’s a grandparent—should be the one who signs it. Otherwise, the IRS may argue that the grandparent is making a taxable gift to the parent, even if that’s not the case.
Many savvy grandparents know about 529 college savings plans, but there’s another, more flexible option that sometimes flies under the radar. With a Coverdell Education Savings Account (ESA), you can help your grandkids save not just for college but also tuition and other related items for elementary and secondary schools.
If you gift money to a 529 plan, beneficiaries can withdraw the money tax-free for qualified educational expenses, which now include using up to $10,000 to pay off student loans, thanks to the SECURE Act. In addition, the law expanded 529 plans to include expenses related to apprenticeship programs. However, ESAs tend to offer more investment options and lower costs.
One stumbling block is the fairly low-income limits for Coverdell plans. For 2022, you can contribute up to $2,000 a year toward a grandkid’s account. According to the IRS, if your modified adjusted gross income is between $95,000-$110,000 a year—or $190,000-$220,000 if you file a joint return, your contribution limit will be gradually reduced. At that point, the allowance starts to taper off. Those whose modified adjusted gross income exceeds $110,000—$220,000 if filing jointly—are completely prohibited from contributing.
However, there is a fairly easy workaround. Simply gift the money to your grandchildren and have them open an ESA on their own. By allowing them to save in advance for a private school in a tax-advantaged way, you’re getting more out of each dollar you spend. What’s more, this is another way to shrink the size of your estate, which can help affluent families steer clear of the dreaded estate tax.
The Bottom Line
The IRS has a couple of provisions that benefit grandparents who want to help pay for private preschool and elementary school. Taking advantage of these carveouts can help shrink your tax bill, both now and in the future. If you’re paying tuition directly, just be sure that the school qualifies for the gift-tax exemption.
This article was originally published in Investopedia on August 10, 2023, written by Daniel Kurt
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1. Internal Revenue Service. Topic No. 313 Qualified Tuition Programs (QTPs). https://www.irs.gov/taxtopics/tc313
2.Private School Review. New York Private Elementary Schools by Tuition Cost, https://www.privateschoolreview.com/tuition-stats/new-york/elementary
3. U.S. Congress. Summary: H.R.1—115th Congress (2017-2018). https://www.congress.gov/bill/115th-congress/house-bill/1
4. U.S. Congress. Summary: H.R.1994—116th Congress (2019-2020). https://www.congress.gov/bill/116th-congress/house-bill/1994
5. Internal Revenue Service. IRS Provides Tax Inflation Adjustments for Tax Year 2023. https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023
6. Internal Revenue Service. “Frequently Asked Questions on Gift Taxes. https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes
7. Internal Revenue Service. Topic No. 310 Coverdell Education Savings Accounts. https://www.irs.gov/taxtopics/tc310
8 Internal Revenue Service. Instructions for Form 709, https://www.irs.gov/pub/irs-pdf/i709.pdf (Page 7)
9. Internal Revenue Service, What’s New-Estate and Gift Tax, https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax
10. Internal Revenue Services. 2021 Instructions for Form 709. https://www.irs.gov/pub/irs-pdf/i709.pdf (Page 2)
11. Internal Revenue Service. Publication 970 Tax Benefits for Education, https://www.irs.gov/pub/irs-pdf/p970.pdf (Pages 47-49)
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