An education plan can pay off for your employees — and your business
An education plan can pay off for your employees — and your business
Your business can set up an educational assistance plan that can give each eligible employee up to $5,250 in annual federal-income-tax-free and federal-payroll-tax-free benefits. These tax-favored plans are called Section 127 plans after the tax code section that allows them.
Plan basics
Sec. 127 plans can cover the cost of almost anything that constitutes education, including graduate coursework. It doesn’t matter if the education is job-related or not. However, you can choose to specify that your Sec. 127 plan will only cover job-related education. Your business can deduct payments made under the Sec. 127 plan as employee compensation expenses.
To qualify for this favorable tax treatment, the education must be for a participating employee — not the employee’s spouse or dependent. Also, the plan generally can’t cover courses involving sports, games or hobbies.
If the employee is a related party, such as an employee-child of the owner, some additional restrictions apply that are explained below.
Plan specifics
Your Sec. 127 plan:
1. Must be a written plan for the exclusive benefit of your employees.
2. Must benefit employees who qualify under a classification scheme set up by your business that doesn’t discriminate in favor of highly compensated employees or employees who are dependents of highly compensated employees.
3. Can’t offer employees the choice between tax-free educational assistance and other taxable compensation, like wages. That means the plan benefits can’t be included as an option in a cafeteria benefit program.
4. Doesn’t have to be prefunded. Your business can pay or reimburse qualifying expenses as they’re incurred by an employee.
5. Must give employees reasonable notification about the availability of the plan and its terms.
6. Can’t funnel over 5% of the annual benefits to more-than-5% owners or their spouses or dependents.
Payments to benefit your employee-child
You might think a Sec. 127 plan isn’t available to employees who happen to be children of business owners. Thankfully, there’s a loophole for any child who’s:
- Age 21 or older and a legitimate employee of the business,
- Not a dependent of the business owner, and
- Not a more-than-5% direct or indirect owner.
Avoid the 5% ownership rule
To avoid having your employee-child become disqualified under the rules cited above, he or she can’t be a more-than-5% owner of your business. This includes actual ownership (via stock in your corporation that the child directly owns) plus any attributed (indirect) ownership in the business under the ownership attribution rules summarized below.
Ownership in your C or S corporation business is attributed to your employee-child if he or she: 1) owns options to acquire more than 5% of the stock in your corporation, 2) is a more-than-5% partner in a partnership that owns stock in your corporation, or 3) is a more-than-5% shareholder in another corporation that owns stock in your corporation. Also, a child under age 21 is considered to own any stock owned directly or indirectly by a parent. However, there’s no parental attribution if the child is age 21 or older.
Ownership attribution for an unincorporated business
What about an unincorporated business? You still have to worry about ownership being attributed to your employee-child under rules analogous to the rules for corporations. This includes businesses that operate as sole proprietorships, single-member LLCs treated as sole proprietorships for tax purposes, multi-member LLCs treated as partnerships for tax purposes or partnerships.
Payments for student loans
Through the end of 2025, a Sec. 127 plan can also make tax-free payments to cover principal and interest on any qualified education loan taken out by a participating employee. The payments are subject to the $5,250 annual limit, including any other payments in that year to cover eligible education expenses.
Talent retention
Establishing a Sec. 127 educational assistance plan can be a good way to attract and retain talented employees. As a bonus, the plan can potentially cover your employee-child. Contact us if you have questions or want more information.
Cost management is critical for companies today
Cost management is critical for companies today
Many business owners take an informal approach to controlling costs, tackling the issue only when it becomes an obvious problem. A better way to handle it is through proactive, systematic cost management. This means segmenting your company into its major spending areas and continuously adjusting how you allocate dollars to each. Here are a few examples.
Supply chain
Most supply chains contain opportunities to control costs better. Analyze your company’s sourcing, production and distribution methods to find them. Possibilities include:
- Renegotiating terms with current suppliers,
- Finding new suppliers, particularly local ones, and negotiating better deals, and
- Investing in better technology to reduce wasteful spending and overstocking.
If you haven’t already, openly address what’s on everyone’s mind these days: global tariffs. Work with your leadership team and professional advisors to study how current tariffs affect your company. In addition, do some scenario planning to anticipate what you should do if those tariffs rise or fall.
Product or service portfolio
You might associate the word “portfolio” with investments. However, every business has a portfolio of products and services that it sells to customers. Review yours regularly. Like an investment portfolio, a diversified product or service portfolio may better withstand market risks. But offering too many products or services exhausts resources and exposes you to high costs.
Consider simplifying your portfolio to eliminate the costs of underperforming products or services. Of course, you should do so only after carefully analyzing each offering’s profitability. Focusing on only high-margin or in-demand products or services can reduce expenses, increase revenue and strengthen your brand.
Operations
Many business owners are surprised to learn that their companies’ operations cost them money unnecessarily. This is often the case with companies that have been in business for a long time and gotten used to doing things a certain way.
The truth is, “we’ve always done it that way” is usually a red flag for inefficiency or obsolescence. Undertake periodic operational reviews to identify bottlenecks, outdated processes and old technology. You may lower costs, or at least control them better, by upgrading equipment, implementing digital workflow solutions or “rightsizing” your workforce.
Customer service
Customer service is the “secret sauce” of many small to midsize companies, so spending cuts here can be risky. But you still need to manage costs proactively. Relatively inexpensive technology — such as website-based knowledge centers, self-service portals and chatbots — may reduce labor costs.
Perform a comprehensive review of all your customer-service channels. You may be overinvesting in one or more that most customers don’t value. Determine where you’re most successful and focus on leveraging your dollars there.
Marketing and sales
These are two other areas where you want to optimize spending, not necessarily slash it. After all, they’re both critical revenue drivers. When it comes to marketing, you might be able to save dollars by:
- Refining your target audience to reduce wasted “ad spend,”
- Embracing lower-cost digital strategies, and
- Analyzing customer data to personalize outreach.
Data is indeed key. If you haven’t already, strongly consider implementing a customer relationship management (CRM) system to gather, organize and analyze customer and prospect info. In the event you’ve had the same CRM system for a long time, look into whether an upgrade is in order.
Regarding sales costs, reevaluate your compensation methods. Can you adjust commissions or incentives to your company’s advantage without disenfranchising sales staff? Also, review travel budgets. Now that most salespeople are back on the road, their expenses may rise out of proportion with their results. Virtual meetings can reduce travel expenses without sacrificing engagement with customers and prospects.
The struggle is real
Cost management isn’t easy. Earlier this year, a Boston Consulting Group study found that, on average, only 48% of cost-saving targets were achieved last year by the 570 C-suite executives surveyed. Beating that percentage will take some work. To that end, please contact us. We can analyze your spending and provide guidance tailored to your company’s distinctive features.
Business owners: Be sure you’re properly classifying cash flows
Business owners: Be sure you’re properly classifying cash flows
Properly prepared financial statements provide a wealth of information about your company. But the operative words there are “properly prepared.” Classifying information accurately isn’t always easy — especially as the business grows and its financial transactions become more complex.
Case in point: your statement of cash flows. Customarily, it shows the sources (money entering) and uses (money exiting) of cash. That may sound simple enough, but optimally classifying different cash flows can be complicated.
Under U.S. Generally Accepted Accounting Principles (GAAP), statements of cash flows are typically organized into three sections: 1) cash flows from operating activities, 2) cash flows from investing activities, and 3) cash flows from financing activities. Let’s take a closer look at each.
Operating activities
This section of the statement of cash flows usually starts with accrual-basis net income. Then, it’s adjusted for items related to normal business operations. Examples include income taxes; stock-based compensation; gains or losses on asset sales; and net changes in accounts receivable, inventory, prepaid assets, accrued expenses and payables.
The cash flows from operating activities section is also adjusted for depreciation and amortization. These noncash expenses reflect wear and tear on equipment and other fixed assets.
The bottom of the section shows the cash used in producing and delivering goods or providing services. Several successive years of negative operating cash flows can signal that a business is struggling and may be headed toward liquidation or a forced sale.
Investing activities
If your company buys or sells property, equipment or marketable securities, such transactions should show up in the cash flows from investing activities section. It reveals whether a business is reinvesting in its future operations — or divesting assets for emergency funds.
Business acquisitions and disposals are generally reported in this section, too. However, contingent payments from an acquisition are classified as cash flows from investing activities only if they’re paid soon after the acquisition date. Later contingent payments are classified as financing outflows. Any payment over the liability is classified as an operations outflow.
Financing activities
This third section of the statement of cash flows shows your company’s ability to obtain funds from either debt from lenders or equity from investors. It includes new loan proceeds, principal repayments, dividends paid, issuances of securities or bonds, additional capital contributions by owners, and stock repurchases.
Noncash transactions are reported in a separate schedule at the bottom of the statement of cash flows or in a narrative footnote disclosure. For example, suppose a business buys equipment using loan proceeds. In such a case, the transaction would typically appear at the bottom of the statement rather than as a cash outflow from investing activities and an inflow from financing activities.
Other examples of noncash financing transactions are:
- Issuing stock to pay off long-term debt, and
- Converting preferred stock to common stock.
In those two instances and others, no cash changes hands. Nonetheless, financial statement users, such as investors and lenders, want to know about and understand these transactions.
Help is available
As you can see, deciding how to classify some transactions to comply with GAAP can be tricky. Whenever confusion or uncertainty arises, give us a call. We can work with you and your accounting team to make the best decision. We can also help you improve your financial reporting in other ways.
Surprise IT failures pose a major financial risk to companies
Surprise IT failures pose a major financial risk to companies
It’s every business owner’s nightmare. You wake up in the morning, or perhaps in the middle of the night, and see that dreaded message: “We’re down.” It could be your website, e-commerce platform or some other mission-critical information technology (IT) system. All you know is it’s down and your company is losing money by the hour.
A report released this past June by cybersecurity solutions provider Splunk drove home the financial risk of unanticipated downtime for today’s businesses. Entitled The Hidden Costs of Downtime, it was produced in partnership with Oxford Economics researchers who surveyed 2,000 large-company executives worldwide. They found that the total cost of downtime for responding businesses, including direct and hidden costs, was a staggering $400 billion annually. The biggest direct cost was revenue loss, averaging $49 million annually per company.
More than revenue
Of course, such losses for large businesses will be proportionately higher given the bigger amounts of revenue they generate. However, small to midsize companies are arguably at even greater risk because they may not be able to readily absorb any substantial revenue losses.
Diminished revenue is just one of the direct costs of surprise IT failures. Others include regulatory fines, blown IT budgets from coping with crises and elevated insurance premiums. Hidden costs may arise from diminished shareholder value (for publicly traded businesses), reduced productivity and brand/reputational damage.
Common threats
Worried yet? The good news is that your business can proactively address the threat of unanticipated technological downtime. The first step is to conduct a formal risk assessment to identify the most likely causes of IT failures based on the distinctive features of your systems and users.
Spoiler alert: You’ll probably find cyberattacks, such as phishing and ransomware scams, are your biggest threat. Unfortunately, these crimes have become so common that you should probably operate under the assumption that you’ll incur attacks fairly often, be they minor or major.
Indeed, the Splunk report attributed 56% of downtime incidents to cybersecurity breaches. Not far behind, however, were software or IT infrastructure failures. These caused 44% of reported downtime. And whether it was a cyberattack or a technological gaffe, human error was identified as the chief underlying cause. So, don’t be surprised if a risk assessment also identifies your employees as a major threat to your company’s ability to stay up and running.
Key strategies
Once you’ve pinpointed the IT risks with the greatest probability of occurring, you can address them. Just a few key strategies to strongly consider include:
Tracking incidents carefully. When downtime occurs, you should have an incident response plan in place to investigate and resolve the matter — as well as to record all pertinent details. Look for trends: As incidents happen more often, the likelihood of a major crisis increases.
Investing wisely in cybersecurity. Today’s companies need to look at substantial investment in cybersecurity as a cost of doing business. However, you must still scale these expenditures to your actual needs and risk level.
Training new hires and regularly upskilling employees. The Splunk report highlighted an essential truth: No matter how technologically advanced businesses become, people still make the difference.
Establishing a disaster recovery plan. As the saying goes, expect the best but plan for the worst. Implement a comprehensive plan involving sound backup policies and procedures, as well as recovery time and point objectives.
Assessing and testing regularly. The risk assessment mentioned above shouldn’t be a one-time thing. Adhere to a strict schedule of assessments and “stress tests” of mission-critical systems.
Continuous improvement
To prevent surprise IT failures at your company, apply a mindset of continuous improvement to all aspects of your policies, procedures and infrastructure. Our firm can help you identify and manage your technology costs.
Unlock your child’s potential by investing in a 529 plan
Unlock your child’s potential by investing in a 529 plan
If you have a child or grandchild planning to attend college, you’ve probably heard about qualified tuition programs, also known as 529 plans. These plans, named for the Internal Revenue Code section that provides for them, allow prepayment of higher education costs on a tax-favored basis.
There are two types of programs:
- Prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won’t be starting college for some time; and
- Savings plans, which depend on the performance of the fund(s) you invest your contributions in.
Earnings build up tax-free
You don’t get a federal income tax deduction for 529 plan contributions, but the account earnings aren’t taxed while the funds are in the program. (Contributors are eligible for state tax deductions in some states.) You can change the beneficiary, or roll over the funds in the program to another plan for the same or a different beneficiary, without income tax consequences.
Distributions from the program are tax-free up to the amount of the student’s “qualified higher education expenses.” These include tuition (up to $10,000 for an elementary or secondary public, private or religious school), fees, books, supplies and required equipment. Reasonable room and board are also qualified expenses if the student is enrolled at least half time.
Tax-free distributions from a 529 plan can also be used to pay the principal or interest on a loan for qualified higher education expenses of the beneficiary or a sibling of the beneficiary.
What about distributions in excess of qualified expenses? They’re taxed to the beneficiary to the extent that they represent earnings on the account. The IRS will also impose a 10% penalty tax.
Your contributions to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the gift tax exclusion ($18,000 in 2024, adjusted annually for inflation). Suppose your contributions in a year exceed the exclusion amount. In that case, you can elect to take the contributions into account ratably over five years starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $90,000 per beneficiary in 2024 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.) You and your spouse together could contribute $180,000 per beneficiary for 2024, subject to any contribution limits imposed by the plan.
Not all schools qualify
Eligible schools include colleges, universities, vocational schools or other postsecondary schools eligible to participate in a student aid program of the U.S. Department of Education. This includes nearly all accredited public, nonprofit and for-profit postsecondary institutions.
However, “qualified higher education expenses” also include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school. A school should be able to tell you whether it qualifies.
Tax-smart education
A distribution from a qualified tuition program isn’t subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be. Contact us with questions about tax-saving ways to save and pay for college.
How inflation will affect your 2022 and 2023 tax bills
The effects of inflation are all around. You’re probably paying more for gas, food, health care and other expenses than you were last year. Are you wondering how high inflation will affect your federal income tax bill for 2023? The IRS recently announced next year’s inflation-adjusted tax amounts for several provisions.
Some highlights
Standard deduction. What does an increased standard deduction mean for you? A larger standard deduction will shelter more income from federal income tax next year. For 2023, the standard deduction will increase to $13,850 for single taxpayers, $27,700 for married couples filing jointly and $20,800 for heads of household. This is up from the 2022 amounts of $12,950 for single taxpayers, $25,900 for married couples filing jointly and $19,400 for heads of household.
The highest tax rate. For 2023, the highest tax rate of 37% will affect single taxpayers and heads of households with income exceeding $578,125 ($693,750 for married taxpayers filing jointly). This is up from 2022 when the 37% rate affects single taxpayers and heads of households with income exceeding $539,900 ($647,850 for married couples filing jointly).
Retirement plans. Many retirement plan limits will increase for 2023. That means you’ll have an opportunity to save more for retirement if you have one of these plans and you contribute the maximum amount allowed. For example, in 2023, individuals will be able to contribute up to $22,500 to their 401(k) plans, 403(b) plans and most 457 plans. This is up from $20,500 in 2022. The catch-up contribution limit for employees age 50 and over who participate in these plans will also rise in 2023 to $7,500. This is up from $6,500 in 2022.
For those with IRA accounts, the limit on annual contributions will rise for 2023 to $6,500 (from $6,000). The IRA catch-up contribution for those age 50 and up remains at $1,000 because it isn’t adjusted for inflation.
Flexible spending accounts (FSAs). These accounts allow owners to pay for qualified medical costs with pre-tax dollars. If you participate in an employer-sponsored health Flexible Spending Account (FSA), you can contribute more in 2023. The annual contribution amount will rise to $3,050 (up from $2,850 in 2022). FSA funds must be used by year end unless an employer elects to allow a two-and-one-half-month carryover grace period. For 2023, the amount that can be carried over to the following year will rise to $610 (up from $570 for 2022).
Taxable gifts. Each year, you can make annual gifts up to the federal gift tax exclusion amount. Annual gifts help reduce the taxable value of your estate without reducing your unified federal estate and gift tax exemption. For 2023, the first $17,000 of gifts to as many recipients as you would like (other than gifts of future interests) aren’t included in the total amount of taxable gifts. (This is up from $16,000 in 2022.)
Thinking ahead
While it will be quite a while before you have to file your 2023 tax return, it won’t be long until the IRS begins accepting tax returns for 2022. When it comes to taxes, it’s nice to know what’s ahead so you can take advantage of all the tax breaks to which you are entitled.
Inflation means you and your employees can save more for retirement in 2023
How much can you and your employees contribute to your 401(k)s next year — or other retirement plans? In Notice 2022-55, the IRS recently announced cost-of-living adjustments that apply to the dollar limitations for pensions, as well as other qualified retirement plans for 2023. The amounts increased more than they have in recent years due to inflation.
401(k) plans
The 2023 contribution limit for employees who participate in 401(k) plans will increase to $22,500 (up from $20,500 in 2022). This contribution amount also applies to 403(b) plans, most 457 plans and the federal government’s Thrift Savings Plan.
The catch-up contribution limit for employees age 50 and over who participate in 401(k) plans and the other plans mentioned above will increase to $7,500 (up from $6,500 in 2022). Therefore, participants in 401(k) plans (and the others listed above) who are 50 and older can contribute up to $30,000 in 2023.
SEP plans and defined contribution plans
The limitation for defined contribution plans, including a Simplified Employee Pension (SEP) plan, will increase from $61,000 to $66,000. To participate in a SEP, an eligible employee must receive at least a certain amount of compensation for the year. That amount will increase in 2023 to $750 (from $650 for 2022).
SIMPLE plans
Deferrals to a SIMPLE plan will increase to $15,500 in 2023 (up from $14,000 in 2022). The catch-up contribution limit for employees age 50 and over who participate in SIMPLE plans will increase to $3,500 in 2023, up from $3,000.
Other plan limits
The IRS also announced that in 2023:
- The limitation on the annual benefit under a defined benefit plan will increase from $245,000 to $265,000. For a participant who separated from service before January 1, 2023, the participant’s limitation under a defined benefit plan is computed by multiplying the participant’s compensation limitation, as adjusted through 2022, by 1.0833.
- The dollar limitation concerning the definition of “key employee” in a top-heavy plan will increase from $200,000 to $215,000.
- The dollar amount for determining the maximum account balance in an employee stock ownership plan subject to a five-year distribution period will increase from $1,230,000 to $1,330,000, while the dollar amount used to determine the lengthening of the five-year distribution period will increase from $245,000 to $265,000.
- The limitation used in the definition of “highly compensated employee” will increase from $135,000 to $150,000.
IRA contributions
The 2023 limit on annual contributions to an individual IRA will increase to $6,500 (up from $6,000 for 2022). The IRA catch-up contribution limit for individuals age 50 and older isn’t subject to an annual cost-of-living adjustment and will remain $1,000.
Plan ahead
Current high inflation rates will make it easier for you and your employees to save much more in your retirement plans in 2023. The contribution amounts will be a great deal higher next year than they’ve been in recent years. Contact us if you have questions about your tax-advantaged retirement plan or if you want to explore other retirement plan options.
You may be liable for “nanny tax” for all types of domestic workers
You’ve probably heard of the “nanny tax.” But even if you don’t employ a nanny, it may apply to you. Hiring a house cleaner, gardener or other household employee (who isn’t an independent contractor) may make you liable for federal income and other taxes. You may also have state tax obligations.
If you employ a household worker, you aren’t required to withhold federal income taxes from pay. But you can choose to withhold if the worker requests it. In that case, ask the worker to fill out a Form W-4. However, you may be required to withhold Social Security and Medicare (FICA) taxes and to pay federal unemployment (FUTA) tax.
2022 and 2023 thresholds
In 2022, you must withhold and pay FICA taxes if your household worker earns cash wages of $2,400 or more (excluding the value of food and lodging). The Social Security Administration recently announced that this amount will increase to $2,600 in 2023. If you reach the threshold, all the wages (not just the excess) are subject to FICA.
However, if a nanny is under age 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. So, if you have a part-time student babysitter, there’s no FICA tax liability.
Both an employer and a household worker may have FICA tax obligations. As an employer, you’re responsible for withholding your worker’s FICA share. In addition, you must pay a matching amount. FICA tax is divided between Social Security and Medicare. The Social Security tax rate is 6.2% for the employer and 6.2% for the worker (12.4% total). Medicare tax is 1.45% each for the employer and the worker (2.9% total).
If you want, you can pay your worker’s share of Social Security and Medicare taxes. If you do, your payments aren’t counted as additional cash wages for Social Security and Medicare purposes. However, your payments are treated as additional income to the worker for federal tax purposes, so you must include them as wages on the W-2 form that you must provide.
You also must pay FUTA tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter. FUTA tax applies to the first $7,000 of wages paid and is only paid by the employer.
Making payments
You pay household worker obligations by increasing your quarterly estimated tax payments or increasing withholding from wages, rather than making an annual lump-sum payment.
As an employer of a household worker, you don’t have to file employment tax returns, even if you’re required to withhold or pay tax (unless you own your own business). Instead, employment taxes are reported on your tax return on Schedule H.
When you report the taxes on your return, include your employer identification number (not the same as your Social Security number). You must file Form SS-4 to get one.
However, if you own a business as a sole proprietor, you include the taxes for a household worker on the FUTA and FICA forms (940 and 941) that you file for the business. And you use your sole proprietorship EIN to report the taxes.
Keep careful records
Keep related tax records for at least four years from the later of the due date of the return or the date the tax was paid. Records should include the worker’s name, address, Social Security number, employment dates, dates and the amount of wages paid and taxes withheld, and copies of forms filed.
Contact us for assistance or questions about how to comply with these requirements.
Plan now to make tax-smart year-end gifts to loved ones
Are you feeling generous at year-end? Taxpayers can transfer substantial amounts free of gift taxes to their children or other recipients each year through the proper use of the annual exclusion.
The exclusion amount is adjusted for inflation annually, and for 2022, the amount is $16,000.
The exclusion covers gifts that an individual makes to each recipient each year. So a taxpayer with three children can transfer a total of $48,000 to the children this year free of federal gift taxes. If the only gifts during a year are made this way, there’s no need to file a federal gift tax return. If annual gifts exceed $16,000, the exclusion covers the first $16,000 and only the excess is taxable.
Note: This discussion isn’t relevant to gifts made to a spouse because they’re gift tax-free under separate marital deduction rules.
Gift splitting by married taxpayers
If you’re married, gifts made during a year can be treated as split between the spouses, even if the cash or asset is actually given to an individual by only one of you. Therefore, by gift splitting, up to $32,000 a year can be transferred to each recipient by a married couple because two exclusions are available. So for example, a married couple with three married children can transfer a total of $192,000 each year to their children and the children’s spouses ($32,000 times six).
If gift splitting is involved, both spouses must consent to it. This is indicated on the gift tax return (or returns) the spouses file. (If more than $16,000 is being transferred by a spouse, a gift tax return must be filed, even if the $32,000 exclusion covers total gifts.)
The “present interest” requirement
For a gift to qualify for the annual exclusion, it must be a “present interest” gift, meaning the recipient’s enjoyment of the gift can’t be postponed to the future. For example, let’s say you put cash into a trust and provide that your adult child is to receive income from it while your child is alive and your grandchild is to receive the principal at your child’s death. Your grandchild’s interest is a “future interest.” Special valuation tables determine the value of the separate interests you set up for each recipient. The gift of the income interest qualifies for the annual exclusion because enjoyment of it isn’t deferred, so the first $16,000 of its total value won’t be taxed. However, the “remainder” interest is a taxable gift in its entirety.
If the gift recipient is a minor and the terms of the trust provide that the income may be spent by or for the minor before he or she reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available. The present interest rule won’t apply.
“Unified” credit for taxable gifts
Even gifts that aren’t covered by the exclusion, and are therefore taxable, may not result in a tax liability. That’s because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $12.06 million for 2022. However, to the extent you use this credit against a gift tax liability, it reduces or eliminates the credit available for use against the federal estate tax at your death.
Questions? Contact us. We can also prepare a gift tax return for you if more than $16,000 is given to a single person this year.
Investing in the future with a 529 education plan
If you have a child or grandchild who’s going to attend college in the future, you’ve probably heard about qualified tuition programs, also known as 529 plans. These plans, named for the Internal Revenue Code section that provides for them, allow prepayment of higher education costs on a tax-favored basis.
There are two types of programs:
- Prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won’t be starting college for some time; and
- Savings plans, which depend on the investment performance of the fund(s) you place your contributions in.
You don’t get a federal income tax deduction for a contribution, but the earnings on the account aren’t taxed while the funds are in the program. (Contributors are eligible for state tax deductions in some states.) You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.
Distributions from the program are tax-free up to the amount of the student’s “qualified higher education expenses.” These include tuition (including up to $10,000 in tuition for an elementary or secondary public, private or religious school), fees, books, supplies and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half time.
Distributions from a 529 plan can also be used to make tax-free payments of principal or interest on a loan to pay qualified higher education expenses of the beneficiary or a sibling of the beneficiary.
What about distributions in excess of qualified expenses? They’re taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.
Eligible schools include colleges, universities, vocational schools or other postsecondary schools eligible to participate in a student aid program of the U.S. Department of Education. This includes nearly all accredited public, nonprofit and for-profit postsecondary institutions.
However, “qualified higher education expenses” also include expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school.
A school should be able to tell you whether it qualifies.
The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the gift tax exclusion amount ($16,000 for 2022, adjusted for inflation). If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Thus, assuming you make no other gifts to that beneficiary, you could contribute up to $80,000 per beneficiary in 2022 without gift tax. (In that case, any additional contributions during the next four years would be subject to gift tax, except to the extent that the exclusion amount increases.) You and your spouse together could contribute $160,000 for 2022 per beneficiary, subject to any contribution limits imposed by the plan.
A distribution from a qualified tuition program isn’t subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be. Contact us with questions about tax-saving ways to save and pay for college.