Taking Advantage of the Tuition Payment Exclusion

November 7, 2017

Section 2503(e) of the Internal Revenue Code of 1986 provides for an unlimited gift tax exclusion for payments of tuition made directly by a donor to an educational institution on behalf of a student for the purpose of education or training. This tuition payment gift exclusion is in addition to and separate from the annual gift tax exclusion limit for gifts made to the student. You may give unlimited amounts of money for tuition costs directly to a student’s college or university without incurring a gift tax. You may simultaneously give tax-free money directly to the student up to the annual gift tax exclusion (14,000 in 2017). If you have the choice of making either a tuition payment or an annual exclusion gift for a particular beneficiary, it will usually be better to make the tuition payment, because that will leave you the option of making an annual exclusion gift later in the year.

Gifts made to a college or university on behalf of a student will likely impact the student’s eligibility for need-based financial aid. This is because third party payments for the benefit of a particular student made directly to a college or university are normally treated as cash support. This is a form of untaxed income to the student and should be reported as such on the Free Application for Federal Student Aid (FAFSA) and other financial aid forms such as the CSS/Financial Aid PROFILE. The U.S. Department of Education defines cash support in the Application and Verification Guide (a source of guidance to college financial aid offices) as including “money and gifts and housing, food, clothing, car payments or expenses, medical and dental care, college costs, and money paid to someone else on his behalf.” Payments by the parents of their dependent student do not count as cash support, except when the parents are divorced or separated and the payment is made by the non-custodial parent. Payments by grandparents, aunts, uncles and other third parties, however, will count as cash support. Eligibility for need-based student financial aid may be reduced by as much as half of the total income received by the student, including both taxed and untaxed income.

If you have questions about this gifting monies to a college on behalf of a student, please contact us.