Giving More Away Tax-free and Tax Breaks on Student Loans

Dear Friends,
Great news about the gift tax! Regular readers of this column know I've explained several times how this tax works.

But what you might not understand is how the gift tax is tied to the estate tax. When we die, the federal government and the states have the right to impose a tax on the value of the assets we leave to others. At the federal level, this is called the "estate tax." Your state might call it an inheritance tax. Most Americans never pay these taxes because they only kick in when the value of the estate is fairly large.

This year, the amount you can leave without owing federal estate tax is $675,000; next year, it jumps to a million dollars. Under the 2001 Tax Act, this "exclusion" amount (so-called because it is the amount of assets excluded from estate tax) gradually increases until it hits $3.5 million in 2009. By 2010, the estate tax itself is slated to disappear, so at that point you'll be able to bequeath an unlimited amount of assets upon your death estate tax-free.

The estate tax is really a tax on the wealthiest Americans. Congress just didn't like the idea of a Rockefeller or a Gates being able to pass all that dough on to their families. For some reason, while we applaud the creativity and determination of entrepreneurs, we resent it when they become "too" successful. Don't get me started...

But it doesn't take an MBA to figure out that the way to avoid a tax on what you own at your death is to give assets away while you're still alive — on our deathbed, if you wish. That's where the gift tax comes in: it limits how much you can give away each year during your lifetime so you can't squirm out of paying the estate tax.

For decades, this amount has been $10,000. Every year, each of us can give $10,000 worth of assets — cash, a car, real estate, securities, etc. — to as many individuals as we want. If the amount we give to any single person exceeds $10,000 in a year, then we have to file a gift tax return. Although we don't owe any tax right away, the IRS keeps tabs on these "excess gifts." When we die, they reduce the amount we give away estate tax-free.

Here's a simple example of how this works (please spare me the emails, I know I'm not going into all the technicalities): assume that when I was alive, I gave my son $40,000 worth of stock in 1995, my daughter $10,000 worth of bonds in 1996 and my niece $15,000 worth of jewelry in 1998.

Since I gave more than $10,000 worth of assets to a single person in 1995 and 1998, I had to file gift tax returns in each of those years for the "excess" amount: $30,000 in 1995 and $5,000 in 1998, for a total of $35,000. That $35,000 comes out of the maximum amount I can pass on to my heirs free of estate taxes. So if I die this year, instead of being able to leave $675,000 to non-spouse beneficiaries free of estate tax, I can only leave $640,000 because I used up part of this amount when I was alive.

Now, here's the good news I promised you: starting next year, the annual gift amount unofficially increases to $11,000. I say "unofficially" because this comes from the folks at CCH, a respected tax data and research firm, and not the IRS (which won't issue a statement about this until next month). The increase is a result of adjusting the current $10,000 limit for inflation. The folks at CCH stand behind their calculations and say the only time they've been wrong was when the government miscalculated the Consumer Price Index.

But this affects more than the amount you can give away annually. George Jones, who calculated this increase for CCH, says the amount you can contribute to a Section 529 college savings plan is tied to the annual gifting limit. Thanks to a special provision of the tax code, you are allowed to contribute five years worth of gifts to a 529 account in a single year without triggering the gift tax — $10,000/year x 5 years = $50,000. (For this to pass muster, you're not supposed to make any more gifts to that child for five years and if you should die during that five-year period, this amount reverts in part back to your estate.)

According to Jones, when the annual gifting amount goes to $11,000 in January, the amount you'll be able to put in a 529 plan without triggering the gift tax jumps to $55,000 ($11,000/year x 5 years).

As you might know, you pay no tax on any gains 529 accounts realize each year. And starting next year, qualified withdrawals used to pay higher education expenses are completely tax-free at the federal level. Some states also waive the tax on withdrawals.

Attention all grandparents, Christmas is coming! This year, consider giving the gift of learning: make a contribution to a child's college savings account instead of handing them a check they'll blow at the mall the next day. It's a gift that will last a lifetime.



Dear Gail,

My husband and I are recent (1998) college graduates and have not been able to deduct the interest from our student loans for the past two years. You mentioned in a recent article that under the new tax bill, couples will be able to claim interest on student loans if their income is below $100,000 instead of the current limit of $75,000.

Is this is going to take place for year 2001 or year 2002? We will be looking forward to it.

Thank you in advance for your time and consideration.

Dear Sarah,

The annual deduction for up to $2,500 in student loan interest has been around for several years, but, as you know, eligibility for the deduction is linked to your income. However, starting next year, the income limits are being increased. In 2002, a single person can take the full deduction if his/her modified adjusted gross income (MAGI) is less than $50,000. A partial deduction is available as your MAGI increases up to a limit of $65,000. Once your MAGI exceeds that amount, this tax break is no longer available.

For married taxpayers, the 2002 income limit is $100,000, phasing out once your MAGI hits 130,000. It's important to realize that this eligibility is tied to "modified" adjusted gross income, which is slightly different from your "Adjusted Gross Income," as found on your tax return. If you're close to qualifying, I suggest you see a competent tax professional who can run a quick calculation for you. (Essentially it involves adding back to your AGI some items which you had been able to deduct.)

Unfortunately, it sounds as if you and your husband earn too much to qualify for this deduction under the limits in effect for this tax year (MAGI of $60,000-$75,000 for married couples; for single taxpayers it's $40,000-55,000). However, unless you experience a big jump in your income, you should be able to take this deduction next year.

Hope this helps!



Dear Gail

As a big fan of Fox News, I was reading your column on the tax changes and I was wondering if you had any information concerning people, like my daughter, who are trying to pay off their student loans, about $50,000 worth, and really struggling. Is there any relief in the new tax changes for this large class of taxpayers?

Absolutely! See above.


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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.