What is it?
Your payment of someone else’s tuition is a qualified transfer (a nongift gift). You are allowed to make this type of gift without incurring federal gift tax or federal generation-skipping transfer tax (GSTT). The payment must be: (1) for tuition, (2) made to a qualified educational organization and (3) made directly to the educational organization. This exclusion allows you to pay an unlimited amount and is in addition to the annual gift tax exclusion. Often overlooked, this exclusion is a great way to transfer wealth to children and grandchildren.
When can it be used?
When payment is for tuition
To avoid it being a gift for gift tax purposes, the payment must be for tuition only. Payments for costs such as supplies, books, dormitory fees and board do not qualify for the exclusion.
When payment is to a qualified educational organization
You must make the payment to an educational organization that meets conditions set out by the IRS. Each of the following requirements must be satisfied. The organization must:
- Maintain a regular faculty
- Offer a regular schedule of courses
- Enroll students on a regular basis
- Have a place where it regularly carries out its educational activities
Example(s): The Correspondence School of Radio Broadcasting offers a correspondence course to students. It is not a qualified educational organization because it has no place where it regularly carries on educational activities. Tuition paid to this school does not qualify for the exclusion.
When payment is made directly to the educational organization
The payment can be made on behalf of anyone (i.e., it need not be a relative), but you must make the payment directly to the educational organization. Payments you make to the student will not qualify.
Strengths
Allows you to make a tax-free gift
Generally, gifts you make are subject to gift tax. The IRS considers payments for tuition made to a qualified educational organization on behalf of a student to be nongift gifts, which are not subject to gift tax or the generation-skipping transfer tax. This can be a great way to transfer wealth to your children and grandchildren.
Allows you to save your applicable exclusion amount
You are allowed to pass a certain amount of your property free of federal gift and estate tax under the applicable exclusion amount (the amount that be sheltered from gift tax and estate tax by the unified credit). Because gifts of tuition are not subject to gift tax, you don’t need to use the applicable exclusion amount to offset these gifts.
Allows you to stretch the annual gift tax exclusion
Because gifts of tuition are not considered gifts for gift tax purposes, you can still give the student up to $18,000 (in 2024) tax free under the annual gift tax exclusion.
May reduce estate tax liabilities
Making a gift of tuition can reduce your estate tax liability by removing the value of the payment from your gross estate.
Allows you to provide an education for someone
Paying for another’s tuition can be a personally gratifying act.
Applies to both full-time and part-time students
The gift qualifies if it is in payment for the tuition of one or more courses.
Applies to a foreign educational organization
Unlike other types of charitable gifts that must be made to organizations located in the United States, a gift of tuition on behalf of another person can be made to a foreign educational institution.
Tradeoffs
Does not apply to some types of educational expenses
The IRS will not allow the exclusion if you make a gift for expenses that are not direct tuition costs. The most common examples include:
- Fees
- Books
- Living expenses
- Supplies
May have negative income tax consequences for third persons
If a dependency relationship exists between the student and another person, the tuition payment that you make will count in the calculation of the student’s support. This could affect who can claim a dependency exemption for the student and could affect the parent’s or student’s ability to claim a personal exemption.
Example(s): If by making tuition payments, Grandma provides more than half the support for her granddaughter during the year, Grandma would be entitled to claim a dependency exemption on her income tax return for the year of the payment.
How to do it
Make the gift directly to the educational organization
To qualify, you must make the payment directly to the educational organization. Giving the payment to the student or to a trust on behalf of the student will not qualify.
Example(s): Kevin attends X University. His friend, Rob, wants to make a $25,000 tax-free tuition gift. To avoid gift taxes, Rob makes the check payable to X University, not to Kevin, and sends it directly to the school.
Get a receipt
If the IRS audits you, you may have to prove that you made the payment directly to the educational organization. Therefore, get a receipt and keep it with your tax records for that year.
Tax considerations
Income Tax
May have negative income tax consequences for third persons
If a dependency relationship exists between the student and another person, the tuition payment that you make will count in the calculation of the student’s support. This could affect who is eligible to claim a dependency exemption for the student and could affect the parent’s or student’s ability to claim a personal exemption.
Example(s): If by making tuition payments, Grandma provides more than half the support for her granddaughter during the year, Grandma would be entitled to claim a dependency exemption on her income tax return for the year of the payment.
Gift and Estate Tax
Avoids gift and generation-skipping transfer taxes
Payments of tuition for another person, no matter for whom and no matter the size, are not gifts and are not reported at all on the federal gift tax or federal generation-skipping transfer tax returns, as long as the payment is made directly to the educational organization.
It also allows you to stretch the annual gift tax exclusion.
May reduce estate tax liabilities
Making the gift can reduce your estate tax liability by removing the value of the payment from your gross taxable estate. It also allows you to save your applicable exclusion amount.
Questions & Answers
Does the exclusion apply to college tuition only?
No. The exclusion applies to tuition for any level of education as long as it is to a qualified educational organization. Therefore, you can exclude payments for your younger child’s parochial school tuition, as well as your older child’s graduate school tuition.