Paying for your children's education is a gift that will last them a lifetime. You can use the IRS gift tax exclusion, unified credit and educational tax credits to offset most if not all of tuition and educational costs. Each gift you make or tax credit you take has a different impact on your taxable income and your taxable estate. By combining your cash gifts and educational credits, you can keep any tax liability to a minimum and possibly lower your taxable income.
Gift/Unified Tax Credit
For 2013, you can make one annual $13,000 tax-free gift to as many individuals, including your child, as you want. You can take the gift tax credit no matter how the gift is used. For example, your child can pay school expenses, purchase a car or invest the gift proceeds. If your gift exceeds the $13,000 gift tax credit limit, the excess may trigger a tax liability. You can use your unified credit to cover the remaining amount. For 2013, the unified credit is $1,772,800.
Gift to Child
If you make the maximum tax-free gift of $13,000, your child can use that gift to pay private school tuition. If you pay your child's tuition for the year and it exceeds $13,000, the IRS considers the amount over the $13,000 a gift taxable to you. To avoid paying gift tax, you can use your unified credit to offset the difference. For example, if your child's yearly tuition is $60,000, you can give him or her a $13,000 tax-free gift. By applying $47,000 ($60,000 minus $13,000) of your unified credit, your $60,000 tuition payment is tax-free.
Gift to School
You can pay for your child’s tuition without using either your gift tax credit or unified credit by paying tuition directly to the school. Schools that qualify for the tuition gift include your child's private nursery school, kindergarten, elementary school, middle school, high school and college. There is no dollar limit on the amount and you can make your tuition gift as often as needed. The gift, however, is limited to tuition. If you pay for your child's books, equipment and supplies, you must use your gift tax credit and unified credit to avoid paying gift tax.
American Opportunity Tax Credit
You can pay for your child's education and lower your taxable income at the same time. The American Opportunity Tax Credit, which replaced the Hope Credit, reduces up to $2,500 of your taxable income when you pay $4,000 or more of your child's tuition, fees, supplies, equipment or books. To take the credit, your income must be less than $180,000. You may use your checking account, savings account or taxable investment account to make the payment.
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