Fall means freshly sharpened pencils and the sound of thousands of parents sighing as first-semester college tuition bills hit their mailboxes. While many parents want to help their children pay for their college tuition, there is some confusion about whether gifting money to children to use for tuition bills is better than paying the school directly.
With the costs of tuition rising every year, it can be important to make sure that you’re making smart financial decisions when it comes to your child’s tuition, whether you’re paying just part of the bill or footing the whole thing. Under IRS rules, there are different tax implications whether you’re gifting money to kids vs paying tuition. (More on that in the next section.)
Depending on your personal circumstances, making the wrong choice could end up costing you in extra taxes, or in a potential reduction to your child’s need-based financial aid.
While we always recommend you speak to a credentialed financial or tax professional about taxes and any other important financial matters, read on to get a high-level overview of some of the basics around this topic.
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What is the Gift Tax?
According to the IRS , the gift tax is “a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.”
That’s a lot of words to essentially mean that if you give someone a gift of property, including money, without getting something of equal value in return, that may be considered a gift. And if you’re gifting, it might be subject to the gift tax. In general, the gifter is responsible for paying the gift tax costs.
Now, before you start worrying if you’ll have to pay a gift tax on the $100 bill you slipped into your niece’s graduation card, it is important to know that the gift tax generally only affects large gifts.
This is because there is an “annual exclusion” for the gift tax, which means that gifts up to a certain amount are not subject to the gift tax. For 2019, the annual exclusion is $15,000 . For spouses, the annual exclusion is $30,000.
The tax code, however, currently contains an educational exemption that may protect tuition paid directly to the school from being subject to the gift tax.
This means it is important to consider all your options and your personal circumstances when deciding whether to gift tuition money or to pay tuition costs directly.
Again, this is simply a broad overview of some of the current guidelines—absolutely speak with a tax professional before making any important financial decisions or if you have any questions about gifting and taxes.
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Gifting Your Money Directly to Your Children
Children are not treated differently when it comes to the gift tax, which means that whether you’re gifting your neighbor money for being really great all those years, or transferring to Junior the $20K you saved up to pay for his sophomore year at a liberal arts school, the gifts are treated the same by the tax code.
This means that a gift you make to your child for the purpose of paying tuition or covering educational expenses may be subject to the gift tax if the gift exceeds $15,000 if you’re single or $30,000 if you’re married and making a joint gift.
With the rising costs of higher education, it is completely conceivable that you’re forking over more than $15,000 or even $30,000 per year in tuition costs. As a result, you might end up on the hook for paying a gift tax on any gifted amount that exceeds the $15,000 or $30,000 exemption.
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Paying College Expenses Directly
Another common option when it comes to paying tuition is to pay the school directly. Paying the school directly may help you avoid paying a gift tax on top of the cost of tuition.
Why doesn’t paying tuition directly count as a gift for the purposes of the gift tax? Thanks to a handy carve-out in the tax code, the gift tax explicitly does not typically apply when it comes to tuition or medical expenses that you pay for someone else.
This means that in some cases, it may save you some cash to pay the school directly rather than first giving the money to your child and having them use it for tuition. It is important to consider all your options, however, as gift tuition payments may impact the student’s need-based aid.
This is more likely when the gifter is a grandparent or other individual, however, as financial aid determinations often already take both student and parents incomes into account. Consider using an online calculator to get an idea of how different scenarios may affect your child’s federal aid award amounts.
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Other Ways to Pay for College
While many parents help with college costs, you may also have other competing priorities, like retirement. If you’re looking for other ways to help cover your student’s educational costs, and your child has already exhausted their federal aid options, you could consider federal parent loans or private parent loans.
One type of federal loan available to some parents is the Parent PLUS Loan, which is a type of federal student loan that may be available to parents with kids enrolled at least part-time in an eligible program. These loans are not subsidized and accrue interest while your child is in school.
If a Parent PLUS loan and other types of financial aid are not sufficient to cover the cost of your child’s education, private student loans could be an option. Private student loans are offered by private financial institutions, not the government.
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Private Student Loans
While private student loans aren’t right for everyone, they could allow your student to borrow money to fill the gap in funding for their college tuition if federal aid isn’t enough.
Unlike federal student loans, the terms of private student loans are set by the lenders. This means that private student loans might not have a fixed interest rate, and the lenders might look at things like your credit history and other financial information to decide if you qualify.
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