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Section 529 Plans - How to Avoid the Kiddie Tax

Posted by attorney Henry Lively

A great way to avoid the Kiddie tax when gifting money to a child is through the use of a Section 529 plan. It will also turn taxable income into tax-free income while allowing you to maintain control of the funds until the child begins post - secondary education.

With a 529 plan a parent or a grandparent can make annual gifts to the plan for the child. The earnings are deferred, and if the funds are used for qualified educational purposes the income is tax-free.

A donor to a 529 plan can elect to treat contributions made in a single year as ratably made over five years. This means that a taxpayer could put $65,000 into a plan and treat it as gifts of $13,000 per year for the next five years. Two things must be done to treat the contributions in this manner:

  1. The donor must file a gift tax return ot report the election. If the donor dies during the five year period, the ratable balance is included in the donor's estate, and
  2. If the donor makes additional gifts in subsequent years, the postponed amount could be subject to gift tax.

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