Gift and Income Tax Strategies for Education

Tax-efficient education funding requires understanding the interplay between gift tax rules, income shifting strategies, and the kiddie tax.

Gift Tax Annual Exclusion

2025-2026 Gift Tax Limits

*The One Big Beautiful Bill Act (OBBBA) made the $15 million lifetime exemption permanent starting in 2026, indexed for inflation thereafter. This eliminated the sunset provision that would have reduced the exemption to approximately $7 million in 2026 under prior law.

How the Annual Exclusion Works

The annual gift tax exclusion allows individuals to give up to $19,000 per recipient per year without:

• Using any lifetime exemption
• Filing a gift tax return (Form 709)
• Paying any gift tax

Multiple Recipients: You can give $19,000 each to unlimited recipients. Married couples can give $38,000 per recipient (gift splitting). No limit on total gifts, just per-recipient limit.

Example: Grandparents with 4 grandchildren can gift $38,000 x 4 = $152,000 per year to 529 plans without gift tax consequences.

Direct Payment of Tuition

Unlimited Gift Tax Exclusion

Payments made directly to an educational institution for tuition are excluded from gift tax without limit. This is separate from and in addition to the annual exclusion.

Requirements:

• Payment must be made directly to the institution
• Must be for tuition only (not room, board, or books)
• Must be for a qualified educational organization

Example: A grandparent can pay $60,000 tuition directly to a university AND give $19,000 to a 529 plan in the same year without gift tax consequences.

Comparison: Direct Payment vs. 529

529 Superfunding (Front-Loading)

The 5-Year Gift Tax Averaging Election

Section 529 allows contributors to front-load up to 5 years of annual exclusion gifts in a single year:

Superfunding Rules and Requirements

Election Mechanics:

1. Contribute up to 5x the annual exclusion to a 529 plan
2. Elect on Form 709 to spread contribution over 5 years
3. The gift is treated as if made ratably over the 5-year period
4. Must file Form 709 in the contribution year

No Additional Gifts: Cannot make additional gifts to the same beneficiary during the 5-year period. Additional gifts would use lifetime exemption.

Death During 5-Year Period: If donor dies before 5 years, remaining years are included in estate. Example: Die in year 3 -> years 4-5 (40% of gift) included in estate.

Kiddie Tax Rules

What Is the Kiddie Tax?

The kiddie tax is designed to prevent parents from shifting investment income to children in lower tax brackets. Under kiddie tax rules, a child's unearned income above a threshold is taxed at the parent's marginal rate.

2025-2026 Kiddie Tax Thresholds

Who Is Subject to Kiddie Tax?

Types of Unearned Income

Kiddie Tax Example

Child's Income: $500 interest + $3,000 dividends = Total unearned income: $3,500

Tax Calculation:

• First $1,350: Tax-free
• Next $1,350 ($1,351-$2,700): Taxed at child's rate (10% = $135)
• Remaining $800 ($2,701-$3,500): Taxed at parent's rate (24% = $192)
• Total tax: $327

Without kiddie tax (all at child's rate): ~$215. Extra tax due to kiddie tax: ~$112.

Income Shifting Strategies

Legitimate Strategies

Despite kiddie tax limitations, some income shifting opportunities remain:

Employ Children in Family Business: Pay reasonable wages for legitimate work. Wages are earned income (not subject to kiddie tax). Business deducts wages; child may pay little or no tax. Can fund Roth IRA with earned income.

Timing of Gains: Defer capital gains until child is 24+. Child's lower tax bracket applies to gains.

Strategies That No Longer Work Well

Filing Requirements

Form 709 (Gift Tax Return)

File Form 709 if:

• Gifts to any person exceed annual exclusion
• Making 529 superfunding election
• Gift splitting with spouse on any gift

Deadline: April 15 of the year following the gift (extensions available)

Form 8615 (Kiddie Tax)

File Form 8615 if child has:

• Unearned income above $2,700 (2025-2026)
• Required to file tax return
• Meets age requirements for kiddie tax

CFP Exam Tip: Know the kiddie tax thresholds ($1,350/$2,700) and understand that the 529 superfunding allows 5x the annual exclusion to be contributed at once with a 5-year election.