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Kiddie Tax and American Opportunity Tax credit

I have a son in college and am considering the following for 2010:

Background. My son is a freshman in college, and we (the parents) are paying his college expenses which are roughly $20,000 per year. I have a 529 account with enough funds for his expenses (plus those anticipated for his younger sister). I am in an AMT-paying situation in 2010, assuming the current exemption levels are extended to 2010. (If they are not I am even deeper in AMT...).

Plan. Gift my son maybe $20,000 in highly appreciated individual stocks. He sells the stocks, and he uses those proceeds to pay tuition, room, board, etc. for 2010. The stocks have a capital gain of around $17,000 so my son would owe roughly 15% in capital gains tax

- or $2500 since he is taxed at my capital gains rate. (Yes, I realize the first $1900 is taxed at his rate, so the effective rate is slightly less than 15%). I don't take my son as a personal exemption, but that doesn't cost me anything since I am in AMT. I will take withdrawals of $16,000 from his 529 during 2010. Since I am owner of the 529 account, I use these funds to replenish my stock holdings. Son claims the American Opportunity Tax Credit on the $4000 of expenses not covered by 529 withdrawals.

Result. My $20,000 in stock no longer has a built-in capital gain since my son used the American Opportunity Tax Credit to offset the capital gains. I use $4,000 of personal funds along with $16,000 of

529 funds to pay for the school year.

Any issues with this plan? Anybody have alternative suggestions?

Thanks.

Reply to
WJB57
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If I followed what you said, your son intends to pay his college expenses using the cash received from the sale of stock you gifted to him. He then intends to claim the AOTC using that amount of his expenses that are qualified higher ed. expenses (room & board don't count). He can do this as you are not claiming him as a dependent. The AOTC will cover his tax liability for the LTCG income.

You intend to withdraw $16000 from the QTP and use the funds to buy securities in a taxable investment account to offset what was gifted to your son.

As the $16000 you intend to withdraw from the QTP will not be used for qualified higher education expenses of the beneficiary, any part of that $16000 that represents earnings (not a return of capital) is taxable to you. In addition, I believe the taxable part, if any, would be subject to the 10% tax penalty because you would not be able to use the penalty exception relating to use of the funds for the AOTC. I may be wrong on the last part.

Reply to
Alan

Alan - thanks for the quick answer. If I withdraw the $16,000 from the 529 account BEFORE we gift him the securities, does that allow me to avoid taxes and penalties? Just how much "specific identification" is required here? If I withdraw $16,000 and turn around and gift my son $16,000 of stock....can you not assert that the $16,000 was used for college costs?

Put another way...what if I withdrew $16,000 and put it into a CD (in my name) for 60 days, then gifted the CD to my son, which was used for college costs. Would that fact pattern result in taxes and penalties on the 529 withdrawal?

Thanks.

Reply to
WJB57

Simply put: You can't use the same higher education expense to get an education credit and not pay tax on the earnings distributed from a QTP.

Reply to
Alan

Alan: Sorry, I may not have been clear. There are $4000 of tuition costs that won't be attibutable to a 529 withdrawal. The total college costs will be $20,000 but I will only withdraw $16,000 from the 529. I believe that is perfectly acceptable, and I am not getting a "double dip" on that $4000 of tuition.

The part that you are questioning is whether I can take $16,000 from the 529, then turn around and gift $16,000 (or more) of appreciated shares to my son....which he uses for college costs. The issue is whether I can claim that the $16,000 was used for college.

Thanks.

Reply to
WJB57

Any college expense not used by your son to obtain the AOTC is available for use by a QTP distribution for his benefit. So, if he spends $20K and uses $4K of tuition and fees for the AOTC, that leaves $16K available to cover a QTP distribution. QTPs cover room and board. AOTC does not. I am not aware of any rule that requires the QTP distribution to go directly to the school. As far as I know, reimbursing the beneficiary for the qualified expenses meets the requirement.

Reply to
Alan

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