Q:
Dear Joe, I am a single adoptive mother. I opened a 529 plan last year and put about $1,000 in. This year, I received a large federal tax credit for my adoption and I put it into the 529 plan, not realizing there is a limit of $12,000. I put in $17,000. Is there anything I can do to avoid the gift tax? When does that tax get paid? There is some exception about a $60,000 contribution. Does that need to be made at one time? For instance, could I put in another $15,000 this year for a total of $32,000 and add more in subsequent years as long as it does not exceed $60,000 over five years? It seems like single parents get the short end of the stick on this one, whereas couples could put in $24,000 annually. Thank you for any help you can provide. -- Melissa
A:
The limit to which you are referring is the gift-tax annual exclusion. This exclusion allows you to make total gifts of up to $12,000 in any year to another individual without having to report them on a gift tax return.
The exclusion is available on a "per donee" basis. For example, if you wish to make gifts to three people, you can give $12,000 apiece (or $36,000 in total) without gift-tax consequences.
Gifts in excess of the $12,000 annual exclusion are referred to as "taxable gifts" and must be reported on an annual gift tax return on federal tax Form 709.
However, a separate gift-tax credit offsets the federal tax on your first $1 million of taxable gifts. So, most people will never have to worry about paying gift tax even when their gifts in any year exceed the $12,000 annual exclusion amount.
Because your contributions to a 529 plan are treated as completed gifts from you to the 529 account beneficiary, your $17,000 in contributions this year means you would normally have to report a $5,000 taxable gift.
But as you have suggested, there is an exception available: You can elect to treat your $17,000 in 529 plan contributions as if they were made ratably over five years instead of all in one year. The result of this election in your particular situation is an annual gift of only $3,400 ($17,000 divided by 5), which is obviously well below the $12,000 annual limit.
In fact, if the annual exclusion amount were to remain at $12,000, you would have room for $8,600 in additional gifts (including 529 plan contributions) in each of the next four years. The annual exclusion is actually scheduled to increase in 2009 to $13,000, meaning you would have room for $9,600 in additional gifts to your child beginning next year.
The same math would apply if you were to increase this year's 529 contributions from $17,000 to $32,000. Rather than reporting a $20,000 taxable gift ($32,000 minus the $12,000 annual exclusion), you could make the five-year election and count only $6,400 as this year's gift. You'll be left with an available exclusion amount of $6,600 in each of the next four years.
You can see why 529 program disclosure materials speak of the possibility of a $60,000 ($120,000 per couple) maximum contribution to a 529 plan for each beneficiary without incurring gift tax. That is the maximum shelter you can achieve in 2008 with the five-year election. In 2009, that number bumps up to $65,000 ($130,000 per couple).
For anyone making sizable contributions to a 529 plan, the gift-tax rules can complicate things, as demonstrated by the discussion above. You can read more about the gift-tax treatment, including the five-year election, in IRS Publication 970 and in the instructions to Form 709.
Don't forget to count other non-529 gifts you may have made to your beneficiary -- or that you intend to make -- when developing your 529 contribution schedule. To the extent you utilize your annual exclusion on gifts of cash or other property, you will have less available for your 529 contributions.