North Carolina Estate Planning Lawyer & Attorney : Trust Counsel, PA : Trust Administration : Serving Chapel Hill, Durham, Raleigh, Pittsboro, Orange County, Chatham County

The IRS has announced that it will soon propose new regulations governing 529 College Savings Plans, which will (I) contain an anti-abuse rule (to prevent using 529 Plans to skirt gift tax rules); (II) determine the estate, gift and GST tax results of contributions, transfers and withdrawals; and (III) create rules for making the 5 year election, address certain income tax issues, and create new record keeping requirements.

Here's the example the IRS gives as an abuse - quite a clever technique!:

Grandparents want to gift $1 million to a child without using any of their $1 million lifetime exclusion. So, the grandparents establish 529 Plan accounts for each of their 10 grandchildren, placing $120,000 in each (the $12,000 annual exclusion, times 2 for 2 grandparents, times 5 to use the 5 year averaging rule) times the number of grandchildren, and naming the child as the account owner. After the 5 years, the child designates a new beneficiary for each account, naming himself. Since Section 529 provides that no gift occurs if the new beneficiary is in the same family and at the same or a higher generational level, the grandparents have succeeded in giving the child $1.2 million without using any of their applicable exclusion.

The child would have to pay income tax and a penalty on any growth when withdrawals are used for non-educational expenses, but overall it would save the family a lot of tax.

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Many parents are deeply concerned about the escalating costs of college and post-graduate education for their children, and how these costs may impact their overall financial and estate planning objectives. If you have college-bound younger family members, you should be aware of an important new technique that can pay for educational expenses, solve income tax issues, and provide an important piece of your estate plan.

You have probably read about 529 College Savings plans (named after the Code section that creates these state-sponsored savings plans). In fact, nearly everyone interested in saving for education has probably investigated the pros and cons of these plans. They are immensely attractive because they are estate tax free, income tax free, and in some states protected from creditors.  North Carolina has a good plan, but does not provide much creditor protection.

Whether you are a parent with future educational obligations for your young ones, or perhaps a loving aunt, uncle, grandparent, or stepparent, state education savings plans provide at least part of the answer. And the other part is this: With a carefully-crafted Educational Trust, you can now control that 529 Plan as an asset of this specially designed planning instrument.

A 529 Plan combined with an Educational Trust provides more flexibility to move assets between siblings (the one in medical school will need more money), and just as importantly, provides a smooth transition should you become incapacitated or die. Further, should you experience a financial emergency, the funds can be returned to you.  It can also provide increased creditor protection.

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I previously blogged about the 2007 income tax deduction available to North Carolina residents to contribute to a North Carolina 529 College Savings Plan account.  A deduction of up to $2,500 is available for single taxpayers and up to $5,000 for married couples filing jointly.  Initially the deductions were subject to income limitations, but no longer.

In addition, rollovers from 529 plans in other states are considered contributions, so those taxpayers (like me) who set up accounts in another state years ago when the NC Plan was lousy, can now do a rollover to the NC Plan and take a deduction, even without making any new contributions.  Rollovers are allowed only once every 12 months.

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Money magazine, in a August 2007 article on College Savings Plans, recommended North Carolina's 529 Plan as a good choice for NC residents.  NC's plan features:

• A tax deduction for contributions (up to $5,000 for a married couple filing jointly)
• Tax free distributions (when used for qualified higher education expenses
• Low fees
• Multiple investment options
• Use at any college in the U.S.

See my other 529 postings for a more detailed description of the tax rules for 529 Plans.

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In 2007, qualified North Carolina taxpayers may deduct contributions to North Carolina's 529 College Savings Plan up to $2,500 for individuals and $5,000 for married couples filing jointly.  Earnings used for qualified college expenses are income tax free.

To qualify for the deduction, for taxpayers  must have adjusted gross income below $60,000 (single), $100,000 (joint), $80,000 (head of household), or $50,000 (married filing separate). You should consult your financial, tax, or other advisor to learn more about how this may apply to your specific circumstances.

For more details, visit the NC College Savings Plan website.

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An article in the February 24-25 issue of The Wall Street Journal describes how 529 College Savings plans can be used to reduce estate taxes.  Earnings on the funds invested in such plans are tax-free if used for qualified college educational expenses.  North Carolina residents also get a small tax deduction for contributions to North Carolina sponsored plans (Click "Continue Reading" for more information).

The plans allow the owner to maintain control over how the funds are used, and even change the beneficiary to another relative or the owner himself.  If the funds are not used for educational expenses, taxes are due on the gains, along with a 10% penalty.

Gift tax rules allow using up to five years of the $12,000 annual gift tax exclusion at once, so that one person can put $60,000 into a plan in one year.  For wealthy grandparents with multiple granchildren, this can add up to substantial estate tax savings.  The current estate tax exemption is $2 million, so persons with estates over this amount may want to consider this technique.  Before establishing the accounts, however, be sure to check with a qualified tax and investment advisor.  There are fees associated with 529 Plans, and investment performance in many types of plans have been lackluster of the last several years.

Check out www.savingforcollege.com for a plethora of information on 529 Plans.

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