Personal 529 inherited by sons - are they taxable?

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JTJjr
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Personal 529 inherited by sons - are they taxable?

Post by JTJjr » Tue Jul 10, 2018 8:16 pm

My wife and I are 73 years old. We have been converting some of our low interest I-bonds to 529s with each of us identified as the beneficiaries. When we die, these 529s will be inherited by our sons. Can our sons use these inherited 529s to pay for their childrens' qualifying educational expenses without paying taxes on the accrued interest? I have spent hours trying to understand this issue, so I would appreciate anyone who can give me a clear and definitive answer.
Thank you. Peace, JTJjr
Aimlessly wandering to discover where I am.

fourwheelcycle
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Re: Personal 529 inherited by sons - are they taxable?

Post by fourwheelcycle » Tue Jul 10, 2018 9:08 pm

I have Nevada Vanguard 529 accounts. Each account has one owner, one named successor, and one beneficiary. If your 529 accounts are similar to mine, to make your scheme work you would want to name one of your grandchildren as the beneficiary for each 529 account and one of your sons as the successor owner of each account.

Alternatively, you could name a grandchild as the beneficiary of each account and one of your sons as the owner of each account now. If you did that, control of the funds would pass from you or wife to your sons now, before you die.

I don't think any of this would be called "inheriting" a 529 account, but I may be wrong.



Edited to drop reference to owner and successor owner as trustees.
Last edited by fourwheelcycle on Wed Jul 11, 2018 6:08 am, edited 1 time in total.

47Percent
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Re: Personal 529 inherited by sons - are they taxable?

Post by 47Percent » Tue Jul 10, 2018 9:14 pm

Have you considered transfering over the accounts to your sons *now* -- i.e. while you are alive and before it becomes their inheritance?

You can designate the grand kids as the beneficiaries, and your sons as the new "owners" of the account. Will require splitting up the account into new accounts.

Because it involves xfer across generations, it will be treated as a gift (there is some confusion about this in the write ups; but safer to assume and plan for it being treated as a gift)

That should really not be an issue unless you and your wife are planning to leave more than $11M of inheritance.

I feel it will be a lot cleaner. No penalties; no taxes; same restrictions as your 529; it can continue to grow tax deferred.

JTJjr
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Location: Orange, France

Re: Personal 529 inherited by sons - are they taxable?

Post by JTJjr » Tue Jul 10, 2018 9:56 pm

WOW!!! This is way more confusing than I expected it to be??? And, I expected this to be confusing!!!
Aimlessly wandering to discover where I am.

Spirit Rider
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Re: Personal 529 inherited by sons - are they taxable?

Post by Spirit Rider » Tue Jul 10, 2018 10:40 pm

Some clarifications and corrections.

A 529 plan has one account owner and one beneficiary. The custodian is the plan administrator (Vanguard, Fidelity, etc... The trustee is always the State sponsoring the plans. 529 plans are owned and therefore are inherited by successor owners (sometimes called participants).

The tax exemption on savings bond interest is only available for qualified educational expenses of the bond owner, their spouse and their dependents. When used to fund 529 plan contributions, they are considered qualified educational expenses of the 529 beneficiary. Assuming the sons are no longer dependents, the OP has taken the only course of action allowing the tax exemption by naming themselves as beneficiaries. The interest tax exemption occurs at the time of contribution and is final.

A change of beneficiary to a lower generation does constitute a gift from the current owner to the new beneficiary. This is subject to gift tax reporting. This does not mean there are any gift taxes due. Whoever changes the beneficiary has the same opportunity as an original donor to use the annual exclusion (2018 = $15K), special 5-year 529 lump sum exclusion (2018 = $75K) and lifetime exclusion (2018 - $11.18M).

I would not be changing the beneficiary while claiming the savings bond educational tax exemption or shortly thereafter. Lest the IRS view this as subject to the step transaction doctrine. It might even be a good idea for each current beneficiary to take a community college course.

kaneohe
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Re: Personal 529 inherited by sons - are they taxable?

Post by kaneohe » Tue Jul 10, 2018 11:23 pm

Sorry for butting in here w/ a similar question..........I have a 529 plan for granddaughter with me as owner. Successor owner is daughter, mother of grandchild. When daughter takes over account, is that a taxable transaction....beneficiary remains the same.

47Percent
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Re: Personal 529 inherited by sons - are they taxable?

Post by 47Percent » Tue Jul 10, 2018 11:39 pm

kaneohe wrote:
Tue Jul 10, 2018 11:23 pm
Sorry for butting in here w/ a similar question..........I have a 529 plan for granddaughter with me as owner. Successor owner is daughter, mother of grandchild. When daughter takes over account, is that a taxable transaction....beneficiary remains the same.
Only beneficiary change can trigger a possible gift tax (or reporting).

I have read that IRS has (had) not issued guidance on who that gift is from.. whether from the owner of the account or the prior beneficiary.

Change in owner does not trigger a gift tax.

BrainDrain
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Re: Personal 529 inherited by sons - are they taxable?

Post by BrainDrain » Wed Jul 11, 2018 1:50 am

529 plans are strange birds. You contribute to them and it’s considered a completed gift to the beneficiary, but you’re later able to change the beneficiary so it doesn’t seem like a completed gift.

About changing the beneficiary from your child to your grandchild, there would be no income tax impact at all as long as you made the changes to an existing account rather than rolling over the funds from one 529 to another. The 529 fund distributions could be used toward qualified educational expenses for the beneficiary without paying tax on the gains in the 529 account. If you change 529 state plans, there can be some state income tax impacts for rolling funds from one state’s plan to another’s, so watch for those.

Changing the beneficiary would be considered a taxable gift for estate/gift tax purposes. Strange thing is that it would be a gift from your child to your grandchild. They could use the 5 year gift treatment that would allow you to transfer $75k in one year - $15k annual exclusion for 5 years. Your child would need to file form 709 for this.

Your child likely has $11.2 million in free lifetime gifts (this free pass is combined with your estate tax exclusion) so even if you went above $75k with the accoun transfer it’s not likely there would be actual gift tax due that year. You would just need to file a 709 return.

Having a 529 owned by your son also could help your grandchild in terms of financial aid, as distributions from a grandparent owned 529 are levied heavily when determining the Expected Family Contribution toward college costs. This only matters if your grandchild would otherwise qualify for need based financial aid.

Bacchus01
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Re: Personal 529 inherited by sons - are they taxable?

Post by Bacchus01 » Wed Jul 11, 2018 6:04 am

So, if I have $50k in an account now with me as the beneficiary, and I want to move that to my sons account in the next twelve months as he enters college, that is treated as a taxable gift?

But, if I just write a check for his college expenses, it’s not treated as a taxable gift?

How does that work? Or is this only for generation skipping (me to my grandchildren)

Spirit Rider
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Re: Personal 529 inherited by sons - are they taxable?

Post by Spirit Rider » Wed Jul 11, 2018 6:58 am

Bacchus01 wrote:
Wed Jul 11, 2018 6:04 am
So, if I have $50k in an account now with me as the beneficiary, and I want to move that to my sons account in the next twelve months as he enters college, that is treated as a taxable gift?
It is treated as a "reportable" gift. Either using only the annual exclusion (2018 = $15K) with the remaining $35K applied against the lifetime exclusion (2018 = $11.18M) or electing the special 529 five-year exclusion (2018 = $75K) with nothing applied against the lifetime exclusion. Gifts are only taxable when the total of all non-excluded amounts reported for a single donee exceed your lifetime exclusion.
But, if I just write a check for his college expenses, it’s not treated as a taxable gift?
There is an unlimited exclusion for tuition directly paid to the institution. If your son is still a dependent, payments for parental support requirements (room and board, healthcare, etc...) are not considered gifts. If you made cash gifts and/or purchased items (vehicle) that exceed the annual exclusion, that would require reporting. Here again, no taxes are required unless and until the lifetime exclusion is exceeded.
How does that work? Or is this only for generation skipping (me to my grandchildren)
The change of 529 beneficiary to any lower generation is considered a new completed gift from the account owner to the new beneficiary. This is true whether it is to children, nieces/nephews, grandchildren, etc...

As has been explained above, this $50K transfer of beneficiary would simply require the completion of Form 709. You would report the $50K gift and elect to treat it as a five-year series of $10K gifts well below the annual exclusion. Not only will no gift taxes be due, but nothing would be applied against the lifetime exclusion.

Spirit Rider
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Re: Personal 529 inherited by sons - are they taxable?

Post by Spirit Rider » Wed Jul 11, 2018 7:35 am

BrainDrain wrote:
Wed Jul 11, 2018 1:50 am
About changing the beneficiary from your child to your grandchild, there would be no income tax impact at all as long as you made the changes to an existing account rather than rolling over the funds from one 529 to another.
This not correct.

It does not matter whether the beneficiary of the account is changed or the assets are rolled over to an account of a different beneficiary. As long as the change of beneficiary/rollover is to another member of the beneficiary's family (defined in IRS PUB 970, page 54) there is no income tax impact. As previously mentioned there may be GST/gift tax reporting required if the new beneficiary is of a lower generation.
Changing the beneficiary would be considered a taxable gift for estate/gift tax purposes. Strange thing is that it would be a gift from your child to your grandchild.
This is also not correct.

The 1998 proposed 529 regulations did state that the gift would be considered from the current beneficiary to the new beneficiary. However, those regulations were never finalized. In 2008, this was superseded in Announcement 2008-17 Advance Notice of Proposed Rulemaking.

The IRS acknowledged that the beneficiary had no control over the 529 account and therefore could not be liable for for any change of beneficiary. Any gift tax liability was to that of the account owner (makes sense). This also, was not finalized. However, Proposed Rulemaking is considered "Substantial Authority" and should be followed
Having a 529 owned by your son also could help your grandchild in terms of financial aid, as distributions from a grandparent owned 529 are levied heavily when determining the Expected Family Contribution toward college costs. This only matters if your grandchild would otherwise qualify for need based financial aid.
This is technically true, but is much more nuanced.

Qualified educational expenses paid by third parties, including grandparent 529 plans, is consider untaxed income to the student. After exclusions, this is assessed at a rate of 50% for the Expected Family Contribution (EFC). However, starting with the 2017/18 school year, The prior prior year is now used for FAFSA applications. The practical effect is that third party 529 plans and/or gifts can be used for the last 2 1/2 years of college without any impact of FAFSA. It may be different for CSS Profile colleges.

Bacchus01
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Re: Personal 529 inherited by sons - are they taxable?

Post by Bacchus01 » Wed Jul 11, 2018 7:37 am

Spirit Rider wrote:
Wed Jul 11, 2018 6:58 am
Bacchus01 wrote:
Wed Jul 11, 2018 6:04 am
So, if I have $50k in an account now with me as the beneficiary, and I want to move that to my sons account in the next twelve months as he enters college, that is treated as a taxable gift?
It is treated as a "reportable" gift. Either using only the annual exclusion (2018 = $15K) with the remaining $35K applied against the lifetime exclusion (2018 = $11.18M) or electing the special 529 five-year exclusion (2018 = $75K) with nothing applied against the lifetime exclusion. Gifts are only taxable when the total of all non-excluded amounts reported for a single donee exceed your lifetime exclusion.
But, if I just write a check for his college expenses, it’s not treated as a taxable gift?
There is an unlimited exclusion for tuition directly paid to the institution. If your son is still a dependent, payments for parental support requirements (room and board, healthcare, etc...) are not considered gifts. If you made cash gifts and/or purchased items (vehicle) that exceed the annual exclusion, that would require reporting. Here again, no taxes are required unless and until the lifetime exclusion is exceeded.
How does that work? Or is this only for generation skipping (me to my grandchildren)
The change of 529 beneficiary to any lower generation is considered a new completed gift from the account owner to the new beneficiary. This is true whether it is to children, nieces/nephews, grandchildren, etc...

As has been explained above, this $50K transfer of beneficiary would simply require the completion of Form 709. You would report the $50K gift and elect to treat it as a five-year series of $10K gifts well below the annual exclusion. Not only will no gift taxes be due, but nothing would be applied against the lifetime exclusion.
Thanks! Since we are funding a 529 for each of my wife and I with the intention to move to our kids and gain a little extra state tax protection, is it advisable to move amounts each year to the new beneficiaries (our kids) up to the annual exclusion to make it simple?

Also, if we change from one beneficiary to another (between kids accounts) is that a gift between them?

Spirit Rider
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Re: Personal 529 inherited by sons - are they taxable?

Post by Spirit Rider » Wed Jul 11, 2018 8:13 am

Bacchus01 wrote:
Wed Jul 11, 2018 7:37 am
Thanks! Since we are funding a 529 for each of my wife and I with the intention to move to our kids and gain a little extra state tax protection, is it advisable to move amounts each year to the new beneficiaries (our kids) up to the annual exclusion to make it simple?
I would not. It would have the appearance that the 529 with you as beneficiaries was a sham transaction solely for the purposes of gaining the savings bond interest exemption. With always having the intent to use the 529 for your children/grandchildren

I would wait until you have completed the savings bond redemptions, a few years have passed and as I suggested you took a community college course and/or some local adult education. This would allow you to make some tax-free withdrawals for your own qualified educational expenses. Establishing some basis for the savings bond interest exemption.
Also, if we change from one beneficiary to another (between kids accounts) is that a gift between them?
No, changes of beneficiaries of the same generation are not considered new gifts and are not subject to GST/gift tax reporting. Also, the gift liability is always to the account owner and not the beneficiary unless they are one in the same.

Bacchus01
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Re: Personal 529 inherited by sons - are they taxable?

Post by Bacchus01 » Wed Jul 11, 2018 2:18 pm

Spirit Rider wrote:
Wed Jul 11, 2018 8:13 am
Bacchus01 wrote:
Wed Jul 11, 2018 7:37 am
Thanks! Since we are funding a 529 for each of my wife and I with the intention to move to our kids and gain a little extra state tax protection, is it advisable to move amounts each year to the new beneficiaries (our kids) up to the annual exclusion to make it simple?
I would not. It would have the appearance that the 529 with you as beneficiaries was a sham transaction solely for the purposes of gaining the savings bond interest exemption. With always having the intent to use the 529 for your children/grandchildren

I would wait until you have completed the savings bond redemptions, a few years have passed and as I suggested you took a community college course and/or some local adult education. This would allow you to make some tax-free withdrawals for your own qualified educational expenses. Establishing some basis for the savings bond interest exemption.
Also, if we change from one beneficiary to another (between kids accounts) is that a gift between them?
No, changes of beneficiaries of the same generation are not considered new gifts and are not subject to GST/gift tax reporting. Also, the gift liability is always to the account owner and not the beneficiary unless they are one in the same.
I'm not using any savings bond redemptions. This is solely for state income tax benefit.

Spirit Rider
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Re: Personal 529 inherited by sons - are they taxable?

Post by Spirit Rider » Wed Jul 11, 2018 4:18 pm

Bacchus01 wrote:
Wed Jul 11, 2018 2:18 pm
Thanks! Since we are funding a 529 for each of my wife and I with the intention to move to our kids and gain a little extra state tax protection, is it advisable to move amounts each year to the new beneficiaries (our kids) up to the annual exclusion to make it simple?
I'm not using any savings bond redemptions. This is solely for state income tax benefit.
I mixed you up with the OP.

However, this still has the appearance that 529 plan(s) with you as beneficiaries is/are a sham transaction with the sole purpose of deriving a tax benefit. Whether your state would view this effectively as tax evasion, I have no idea.

Bacchus01
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Re: Personal 529 inherited by sons - are they taxable?

Post by Bacchus01 » Wed Jul 11, 2018 6:38 pm

Spirit Rider wrote:
Wed Jul 11, 2018 4:18 pm
Bacchus01 wrote:
Wed Jul 11, 2018 2:18 pm
Thanks! Since we are funding a 529 for each of my wife and I with the intention to move to our kids and gain a little extra state tax protection, is it advisable to move amounts each year to the new beneficiaries (our kids) up to the annual exclusion to make it simple?
I'm not using any savings bond redemptions. This is solely for state income tax benefit.
I mixed you up with the OP.

However, this still has the appearance that 529 plan(s) with you as beneficiaries is/are a sham transaction with the sole purpose of deriving a tax benefit. Whether your state would view this effectively as tax evasion, I have no idea.
Kinda like a backdoor Roth?

Spirit Rider
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Re: Personal 529 inherited by sons - are they taxable?

Post by Spirit Rider » Wed Jul 11, 2018 7:44 pm

Bacchus01 wrote:
Wed Jul 11, 2018 6:38 pm
Spirit Rider wrote:
Wed Jul 11, 2018 4:18 pm
Bacchus01 wrote:
Wed Jul 11, 2018 2:18 pm
Thanks! Since we are funding a 529 for each of my wife and I with the intention to move to our kids and gain a little extra state tax protection, is it advisable to move amounts each year to the new beneficiaries (our kids) up to the annual exclusion to make it simple?
I'm not using any savings bond redemptions. This is solely for state income tax benefit.
I mixed you up with the OP.

However, this still has the appearance that 529 plan(s) with you as beneficiaries is/are a sham transaction with the sole purpose of deriving a tax benefit. Whether your state would view this effectively as tax evasion, I have no idea.
Kinda like a backdoor Roth?
I have also given 10-12 reasons on this forum why despite the crusade of Michael Kites. There was never a problem with Backdoor Roths.

I have given my opinion on your totally different situation that this could be a problem. You are free to ignore it.

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