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Education Funding Techniques

Income splitting is simply defined as the shifting of income to someone who is in a lower tax bracket than you are. The concept is used primarily to shift income from high tax bracket parents to their lower tax bracket children.

Under the Tax Reform Act (TRA) '86 this became more difficult.

The tax code provides for the taxation of a child's (under age 14) net unearned income, over a certain amount, at his or her parents' higher marginal tax rate, making the shifting of unearned income to your children much less desirable. However, the following techniques have some merit, particularly for those children who have attained the age of fourteen.

Uniform Gift to Minors Act (UGMA) and Uniform Transfer to Minors Act (UTMA) -- This is an outright gift to a custodial account for the benefit of a minor child. The parent can retain control over the management of the assets in the account. The normal rule regarding the annual $10,000 limit for gift tax exclusion applies.

One possible problem with the UGMA and UTMA is that upon reaching a certain age, the child has full discretionary control over the accumulated trust assets.

Transfer of Appreciating Property -- Would allow non-income-producing property with good opportunity for appreciation to be transferred to the minor before the attainment of age fourteen. The property would then appreciate up to or beyond the child's age of fourteen and could then be sold, allowing the gain to be taxed in the child's lower bracket.

Check with your advisors about different applications of this concept.

Irrevocable Living Trust-- There are many types of irrevocable living trusts. For purposes of income splitting, it is a trust created to receive a one-time gift of cash or property or ongoing annual gifts of the same for purposes of shifting the income produced by the property to the children.

This is probably the most conservative method of shifting income while maximizing management control. An irrevocable living trust can also permanently remove assets from the grantor's estate, reducing future estate taxes.

Cash Value Life Insurance -- This type of insurance contract may be considered one of the best tax-sheltering devices remaining after recent tax legislation. Parents, grandparents, or other family members may pay the premiums as gifts, and the cash value build-up inside the policy is free of tax during the accumulation period. When the time for college arrives, the needed cash may be withdrawn from the policy (usually on a tax-free basis), or the cash values can be borrowed at a low interest rate.

Note that contracts entered into after June 20, 1988 must satisfy the Technical and Miscellaneous Reform Act (TAMRA) "7-pay test" or incur tax treatment on distributions (including loans) similar to deferred annuities.