Maximizing a gift program with tuition and healthcare payments - tax-free cash transfers - Personal Finance - Column

Healthcare Financial Management, Jan, 1992 by William G. Kistner

As a new year arrives, it often brings resolutions to do better, especially with finances. One idea for a taxpayer to consider in 1992 is a way of enhancing the amount of gifts made to family members as part of an overall estate plan.

The annual gift tax exclusion of $10,000 ($20,000 for a married couple) is the amount one person can give to any number of recipients each year without incurring gift tax or eating into his or her unified credit, which permits $600,000 of lifetime tax-free transfers. The person who makes the gift is responsible for the tax. While gifts of $10,000 per person may seem substantial, they may not be enough to make a dent in a sizable estate tax problem. Fortunately, another avenue exists to maximize annual tax-free transfers.

Tuition and medical expenses. A lesser known variation from the $10,000 annual gift tax exclusion permits an individual to make unlimited payments of someone else's tuition or medical expenses without incurring gift tax. These payments, allowed in addition to the regular $10,000 per donee exclusion, can, in proper situations, produce a dramatic estate tax reduction.

Both tuition and medical expenses have increased at a pace far outstripping inflation for several years. A wealthy grandparent today could significantly reduce his or her estate tax by paying tuition bills for several grandchildren. These payments also are excluded from the generation-skipping transfer tax.

Tuition and medical payments must meet certain limitations to qualify for this exclusion:

* Payments must be made directly to an educational institution or healthcare provider on behalf of a donee;

Only tuition payments qualify-not room, board, or other expenses;

Medical payments must be for tax-deductible items. Cosmetic surgery, for instance, is not covered by this exclusion; and

Only the portion of a medical expense not reimbursed to a donee by insurance will qualify for exclusion.

Case in point. The following example illustrates gift and estate tax savings a taxpayer can achieve by appropriate use of the exclusion fir education and medical expenses:

Mike, age 75, is a widower with two children (now in their 40s), four grandchildren, and a gross estate worth slightly more than $2 million.

Mike's grandchildren range in age from 14 to 24, and attend either prep school, private college, or graduate school. Total tuition for all grandchildren is $60,000. One grandchild severely injured a knee, resulting in doctor and hospital bills of $2,000 after insurance reimbursement.

If Mike died today, his estate would be liable for about $588,000 in Federal estate tax, after allowance for the unified credit. But Mike has a modest lifestyle and already makes $10,000 exclusion gifts to his children and to trusts for his grandchildren each year. Mike decides to pay the $60,000 tuition payments and the $2,000 unreimbursed medical bill, reducing his taxable estate this year by the $60,000 in gifts and the full $62,000 paid out, but none of the $600,000 unified credit equivalent is used.

Mike's estate saves Federal estate tax on $62,000 at a marginal rate of 49 percent, or $30,380 for this year's payments alone. He can avoid additional tax by continuing to make these types of payments. (It may even be possible for Mike to prepay a few years of tuition if he were in poor health and not expected to live for long.) It is doubtful that Mike's children would complain about being relieved of this tuition responsibility, knowing that, otherwise, they would receive (in aggregate) only 51 percent of Mike's $2 million estate.

Keeping the kids happy. If grandparents want to take advantage of their ability to make tax-free tuition payments for grandchildren and still want each child to benefit equally from their estate, they may need to draft special will provisions to equalize total lifetime and testamentary distributions among their heirs.

State law considerations. Courts in some states have held that private school or college education is a support obligation of parents with a high standard of living. If grandparents pay tuition for grandchildren in one of these states, they may be providing their children with taxable income because they are satisfying the children's support obligations. Parents should be sure to check with their tax advisors about possible application of this rule.

There are relatively few ways a person can reduce the size of his or her estate quickly without incurring taxable gifts, and Congress has considered reducing the annual limit. Good planning dictates making the most of available strategies-including maximizing use of the unlimited exclusion for education and medical payments.