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As I indicated in my last Tax Bulletin, the tax advantages of using a Qualified State Tuition Program (Q.S.T.P.), such as California Golden State Scholarshare (G.S. Scholarshare), have improved so much that anyone who can afford to save -- with children, grandchildren, nieces, nephews, grandnieces or grandnephews -- should look at this program.
This is a continuation of my Fall Tax Bulletin. Please contact me if you have not received a copy of that Bulletin. This Tax Bulletin will cover features of Q.S.T.P.s not covered in the last Tax Bulletin.
CALIFORNIA TAXATION OF NON-CALIFORNIA Q.S.T.P.'S
In Part 1 of this discussion, I indicated that California gave special, more favorable, tax benefits to its Q.S.T.P., the Golden State Scholarshare, than it did to other states Q.S.T.P.'s. I have since found out that is not true. California treats all Q.S.T.P.s the same. Also, in addition to Fidelity and Merrill Lynch, Salomon Smith Barney is a sponsor for Q.S.T.P.s. The Golden State Scholarshare program is managed by TIAA-CREF, who are well known as managers of pension investments.
WHAT CAN YOU SPEND YOUR Q.S.T.P. FUNDS ON?
1. Q.S.T.P.s may be used not only for tuition, but also for required school supplies and equipment and room and board. There will be limits on the amount that can be allocated to room and board. It appears the limit would be something like the school's posted room and board charge, or $2,500 for students living off-campus and not at home. If you spend more than allowed on room and board, then you would be subject to a 10% penalty as with other non-education withdrawals from the Q.S.T.P.
2. Q.S.T.P.s may also be used to pay expenses not only at public and nonprofit colleges and universities also at any school that is an eligible educational institution for purposes of the educational credits, e.g. Heald Colleges and Bryman College, as well as community or junior colleges.
TRUST FUNDS NOT RESTRICTED TO ORIGINAL BENEFICIARY
We all realize that saving for a child's education is no guarantee that the child will in fact be interested and able to take advantage of the funds saved for college. The legislation for Q.S.T.P.'s acknowledges this and provides for different alternatives.
If the original beneficiary decides against going to college, or plans a course of study that the Q.S.T.P. donor(s) do not want to support, the Q.S.T.P. can be rolled over to one or more other potential students in the same family. Q.S.T.P.'s define family fairly broadly, including siblings, children, stepchildren, spouses, in-laws, nieces and nephews.
If a child's interest is transferred to another beneficiary, there is no estate or gift tax consequence if the two beneficiaries are in the same generation. If a beneficiary's interest is transferred to a beneficiary in a younger generation (e.g. parent to child or aunt to niece), there is a taxable transfer, but the five-year averaging rule described below can be used to reduce the impact of the transfer on estate and gift tax.
BENEFACTORS RETAIN CONTROL
In many ways, Q.S.T.P.s are a replacement for a tax planning tool of the 1970's and early 1980's -- the short term trust. The way these worked was that you would put money into a trust for a term of no less than 10 years. The income was taxed to the trustor to your children for 10 years and the funds used for their education. After your children's education was completed, the principal of the Trust would return to you.
Q.S.T.P.s offer the closest replacement to the short term trust that we have seen. Parents, grandparents, etc. can fund a Q.S.T.P., and then change the beneficiary or withdraw the Q.S.T.P. money right up until the child is admitted to college. There would a 10% penalty on the earnings withdrawn, but having this control could be comforting to elderly beneficiaries who worry they might need the money for a medical catastrophe or for long-term nursing care.
GIFT AND ESTATE TAXATION
As you know, any benefactor can give up to $10,000 a year per donee a year. However, one limit on this exclusion from gift tax is that it must be a gift of a "present interest" -- and usually gifts in trust or with strings attached such as with Q.S.T.P.s do not qualify. But Congress has allowed gifts to Q.S.T.P.s to qualify for the exclusion from gift tax.
With a Q.S.T.P., a benefactor can elect to treat up to $50,000 contributed in one year to one beneficiary as made over 5 years, thereby changing the $50,000 into five annual $10,000 gifts each eligible for the annual exclusion.
Why would you want to make one $50,000 contribution? To get the money invested sooner -- making tax deferred money sooner and faster. If the donor dies before the fifth year, only a pro-rated portion of the $50,000 is shielded from estate tax, but the growth in the account is still not subject to estate tax.
I do want to note that gifts to family members or other beneficiaries for their education that are paid directly to colleges and universities are also excluded from gift and estate taxation, and do not even count as part of the $10,000 a year annual exclusion from estate tax. But Q.S.T.P. would be useful for the grandparent who cannot be sure he or she will be there to pay for the tuition directly, and to pay for room and board and other indirect education expenses.
IMPACT ON FINANCIAL AID IS UNCLEAR
Because of donor's control over funds (discussed above), it is thought that the money in a Q.S.T.P. will be counted as the parent's funds and not the children's. Currently, the standard financial formula calls for students to spend 35% of their own assets on college bills, while parents are on the hook for 6.5%. The U.S. Dept of Education hasn't clarified whether G.S. Scholarshare assets be counted as an asset of the parent or the student. The agency did advise another state, however that the assets would be considered the parents.
FOR MORE INFORMATION
Here is another recommended WEB site on this subject -- http://www.savingforcollege.com. This site is "run" by Joseph F. Hurley, the author of The Best Way to Save for College and is considered to be the Q.S.T.P. guru. On his site, he compares the different state college savings plans. If your family has strong connections to another state, or if you are an alumni of a college or university in another state, you should check out the other state's Q.S.T.P. Some other state's Q.S.T.P. offer incentives quite different from California.
The WEB site for the California Golden State Scholarshare program is http://www.scholarshare.org/.
Copyright Eleanor Hansen 2000
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