Question

Lynn Swartz's husband died 3 years ago. Her parents, who have income of over $200,000 per year, want to ensure that funds will be available for the education of Lynn's 8-year-old son, Eric. Lynn is currently earning $45,000 a year. Lynn's parents have suggested that they start a savings account for Eric. They have calculated that if they invest $4,000 per year for the next 8 years, sufficient funds will be available at the end of 10 years for Eric's college expenses. Lynn realizes that the tax treatment of the investments could significantly affect the amount of funds available for Eric's education. Complete the letter advising her about options available to her parents and to her for Eric's college education. Young, Nellen, Hoffman, Raabe, & Maloney, CPAS 5191 Natorp Boulevard Mason, OH 45040 September 7, 2019 Ms. Lynn Swartz 100 Myrtle Cove Fairfield, CT 06824 Dear Lynn: You asked me to consider the tax-favored options for accumulating the funds for Eric's college education. An added complication (and opportunity for tax planning) in your case is that the funds will come from your parents, who are in a much tax bracket than either you or Eric. Various options are discussed below. Within some of the options, suboptions are available (i.e., your parents could give the funds to you or to Eric before the investments are made).

Answer 1

Hoffman, Maloney, Raabe, and Young, CPAs

5191 Natorp Boulevard

Mason, OH 45040

September 7, 2019

Ms. Lynn Swartz

100 Myrtle Cove

Fairfield, CT 06824

Dear Lynn:

You asked me to consider the tax-favored options for accumulating the funds for Eric’s college education. An added complication (and opportunity for tax planning) in your case is that the funds will come from your parents, who are in a much higher tax bracket than either you or Eric. Various options are discussed below. Within some of the options, sub options are available; that is, your parents could give the funds to you or to Eric before the investments are made.

·          Your parents could purchase stock certificates, bonds, certificates of deposit, or other investments in Eric’s name with them as custodian. The first $1,000 of the income (after subtracting a $1,200 standard deduction) would be subject to Eric’s marginal tax rate. Income above that would be taxed at your marginal tax rate. This option provides the maximum flexibility while removing the income from your parents’ high marginal tax bracket.

·          Your parents could buy tax-exempt bonds and accumulate the interest, which is excludible from gross income. However, the rate of return on the investment may be much lower than could be obtained with taxable options.

·          Your parents may give the $4,000 a year to you, and you could purchase Series EE bonds in your name and use the proceeds to pay Eric’s educational expenses. No tax will be due on the interest. This option would not be available if your parents purchased the bonds because the exemption is not available to taxpayers in your parents’ income class. That is, the potential exclusion would be completely phased out for your parents.

·          Your parents could invest the funds in Connecticut’s Qualified Tuition Program. This program provides a hedge against inflation in tuition cost, but little or no other return on the investment. The earnings of the fund, including the tuition savings, will not be included in gross income provided the contribution and earnings are used for qualified education expenses.

If I can be of further assistance in helping you make this decision and explain the options to your parents, please call me.

Sincerely your,

John J. Jones, CPA

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