Taking IRA money to pay for son's medical school tuition

[ajahearn]

I spoke to a finance/tax person and they told me that as long as my wife and I 1) do not exceed the $16k each for 2022, and 2) have the money sent directly to his school, we would not even have to declare these.  Which we did.  We did not have any withholding done.  But now I have received two 1099-R forms from Schwab marked as Simple IRA and when I try to mark them as GIFT, TT says that is not allowed.  So do I just not include them on my taxes?   Do we owe taxes on this money?  It seems I can file a form 709 to avoid the taxes (but it lowers my lifetime exclusion) - am I correct here?

And a follow-up, this year his tuition has increased but I also learned that for 2023 the cap is now $17/per person, which is great but I also need to pay for his medical insurance which is another $4k.  Now it seems I can pay both but I definitely need to file a form 709 - is my understanding correct?

Thanks in advance.

[Hal_Al]

Money for education is exempt from the gift tax. There is no limit. You do not need to file a form 709. Reference: https://www.savingforcollege.com/article/tuition-gift-tax-exclusion

Using money from your IRA for education, is not exempt from income tax. It is, however an exception to the 10% early withdrawal penalty.  Reference: https://www.investopedia.com/ask/answers/082515/can-my-ira-be-used-college-tuition.asp

 Q. So do I just not include them on my taxes? 

A. No. Those 1099-Rs are taxable income.  The TurboTax interview will guide you on claiming the penalty exception on form 5329.

Q. Do we owe taxes on this money? 

A. Yes

Q. It seems I can file a form 709 to avoid the taxes (but it lowers my lifetime exclusion) - am I correct here?

A. No.  

It appears your advisor mixed up the rules or you misunderstood what you were told. 

[ajahearn]

Thanks, we were both over 60 when we withdrew the money.  So what code do I use when I enter the 1099R into TT? 

Also I still do not understand then the purpose of 709 and the lifetime exclusion.  It seems that is intended for this somehow.

[Hal_Al · Accepted solution]

Q. We were both over 60 when we withdrew the money.  So what code do I use when I enter the 1099R into TT? 

A.  Code 7, normal distribution, is what Schwab should have put in box 7 of the 1099-R.

Q. I still do not understand then the purpose of 709 and the lifetime exclusion?

A. If you make a gift of more than the annual limit ($16K in 2022), you must file form 709 to notify the IRS of the reduction in your  lifetime exclusion. 

Q. It seems that is intended for this somehow?

A. No, for two reasons; 1. you didn't exceed the limit and 2. there is an exception for the direct payment of educational expenses for certain relatives.  

[NCperson]

@ajahearn - the lifetime exclusion:

the first $12.92 million of your estate is exempt from estate tax. 

the first $17k you give any one person is tax free. 

if you give someone more than $17k in a year, then in effect, the part that is over $17k 'eats into' the $12.92 million of the estate that is tax free from estate tax.

Let's say you give someone $100k in on year as a gift.  You would have to report $83k on Form 709 indicating that you now only have $12,837,000 remaining to be except from estate tax.  You are simply reporting that gift on form 709 but it doesn't create the need to make a tax payment. 

make sense? 

[ajahearn]

I believe I understand that much of the estate tax - when I die and give the money in my estate away, any funds below the exemption are not taxed.   If I withdraw money now and give it away, I have to pay taxes on that money as if I received it.  What I fail to understand is why cannot I not lower my estate exemption in lieu of paying taxes now?  

[Hal_Al]

Q.  What I fail to understand is why cannot I not lower my estate exemption in lieu of paying taxes now?  

A. That is exactly what filing form 709 does.  It lowers your estate exemption.  You do NOT pay any estate tax now (unless you gave away $12.92 million). 

[ajahearn]

But I have been told that I need to pay taxes on the money I am gifting my son.  Is this incorrect?  If I file 709 do I then not report the gifts?

[Hal_Al]

A. But I have been told that I need to pay taxes on the money I am gifting my son.  Is this incorrect? 

Q. Yes and no.  You do not pay tax because you made a gift.  You pay tax because you have taken an IRA distribution.

Q. If I file 709 do I then not report the gifts?

A. Filing a form 709 is how you report a gift, if you needed to report them. In your case, you do not need to report the gift, for two reasons: 1. your gift didn't exceed the limit ($16K) and 2. there is an exception (to the form 709 requirement) for the direct payment of educational expenses for close relatives.  "Direct payment" means you paid the school, rather than giving him the money.

[ajahearn]

Sorry, going to try this one last time but this time using numbers.  Let's say I have exactly $16k in my IRA and $4k in my bank account when I die.  The $4k+$16k, a total of $20k, goes to my son as I will it all to him.  This money is not taxed to my estate or to my son - correct?

Now let's say instead the day before I die, I give $16k to my son's school as an educational gift.  Now I have to pay taxes on it of $4k.  The net is my son gets $16k for tuition but nothing else from my estate as I have nothing to give. 

If my understanding here is correct this makes no sense.  I thought I could use the 709 form to take an early cut of my estate exemption by the $16k so that I don't have to pay the $4k.  This makes more sense to me as then my son would get the $4k when I die.  

It seems clear to me that I do not understand the estate tax exemption.

[NCperson]

<<

Sorry, going to try this one last time but this time using numbers.  Let's say I have exactly $16k in my IRA and $4k in my bank account when I die.  The $4k+$16k, a total of $20k, goes to my son as I will it all to him.  This money is not taxed to my estate or to my son - correct?>>

technically, not correct.  The IRA passes to your son, outside your will, assumimg you named him as the beneficiary of your IRA.   He will have 10 years to liquidate the IRA and those distributions are taxable to him (assuming this is a TRAD IRA and not a ROTH IRA).  You NEVER get out of the tax on a TRAD IRA.  Yes, the $4k passes to him via the instructions of your will and are free of estate taxes because your estate value is below $12.92 million. 

The IRA is NOT part of your estate and therefore is not part of the $12.92mm exemption.

Here is how the estate tax exemption works.  Under current law, YOU can pass $12.92 million dollars from your estate tax free, whether that is passed after you die or before you die.   The first $17k (2023) of gifts given to an indiviudal each year while you are alive are not part of the $12.92mm exemption. 

So let's say you give someone $100,000 this year. $17k is a gift with no reporting requirement.  $83k is also a gift but with a reporting requirement as it reduces your $12.92mm estate limit by $83k.   There is no tax due in either case. 

PS - and maybe you are over this misunderstanding: Money coming out of a TRAD IRA is a taxable event.  Does not matter what you do with the money.  it is going to be taxed.  To the extent the money went into the IRA on a pre-tax basis,  the IRS is going to take their fair share whenever you (or the beneficiary of the IRA) takes a distribution. 

[ajahearn]

Thanks, you answered my question.  The money is taxable since it is from a traditional IRA.   You also corrected me on the estate inheritance - also taxable.  So the only benefit here is that the money give him this way is not taxable to him.  

[Hal_Al]

@NCperson  said  " You NEVER get out of the tax on a TRAD IRA" distribution.

There is an exception, the Qualified Charitable Distribution (QCD).  Starting in 2018, if you have the IRA administrator send money directly to a qualified charity, you do not have to pay tax on that distribution.  It does get reported on your tax return,  on line 4a of form 1040.  But is does not get reported on line 4b (taxable amount).

[NCperson]

@Hal_Al -  technically you are correct - the tax can be avoided by executing QCDs (assuming the OP or the beneficiary is eligbile).  However, the cost of doing that is giving up the principle, which is even more than the tax!  So, in the example cited, one way to put the entire $16k back into one's own pocket is take distributions and not go over the standard deduction (so there is no tax); it may have to occur over a number of years to accomplish that and not everyone's taxable situation can accomodate that. . 

[ajahearn]

Thanks again, so fundamentally my problem is the gift for education is not the same as a recognized charity.  That is unfortunate but it seems to be what I am hearing everywhere.