[Federal Register: January 18, 2008 (Volume 73, Number 13)]
[Proposed Rules]
[Page 3441-3446]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18ja08-21]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-127127-05]
RIN 1545-BE68
Guidance on Qualified Tuition Programs Under Section 529
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Advance Notice of Proposed Rulemaking.
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SUMMARY: This document invites comments from the public regarding rules
under section 529 of the Internal Revenue Code (Code) that the IRS and
the Treasury Department expect to propose in a notice of proposed
rulemaking. The rules focus mainly on the transfer tax provisions
applicable to accounts (section 529 accounts) in Qualified Tuition
Programs (QTPs). It is anticipated that these rules will generally
apply to section 529 accounts after the effective date of final
regulations. All materials submitted will be available for public
inspection and copying.
DATES: Written and electronic comments must be submitted by March 18,
2008.
ADDRESSES: Send written comments to: Internal Revenue Service, Attn:
CC:PA:LPD:PR (REG-127127-05), room 5203, POB 7604 Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered between the
hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-127127-05), Courier's
Desk, Internal Revenue Service, 1111 Constitution Ave., NW.,
Washington, DC, or sent electronically, via the Federal eRulemaking
Portal at http://www.regulations.gov (IRS-REG-127127-05).
FOR FURTHER INFORMATION CONTACT: Concerning submissions, Richard A.
Hurst at Richard.A.Hurst@irscounsel.treas.gov or, (202) 622-7180;
concerning rules relating to estate, gift, and generation-skipping
transfer tax issues, Mary Berman, (202) 622-3090; concerning other
proposed rules, Monice Rosenbaum, (202) 622-6070 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Prior Administrative Guidance
A Notice of Proposed Rulemaking under section 529 was published in
the Federal Register on August 24, 1998 (REG-106177-97; 63 FR 45019)
(the 1998 proposed regulations). Additional guidance was published in
Notice 2001-55 (2001-2 CB 299) and Notice 2001-81 (2001-2 CB 617).
Notice 2001-55 provides guidance regarding the statutory restriction
against investment direction. Notice 2001-81 provides guidance on
recordkeeping, reporting and other requirements applicable to QTPs in
light of certain amendments made to section 529 by the Economic Growth
and Tax Relief Reconciliation Act of 2001 (Pub. L. 107-16, 115 Stat.
38) (EGTRRA). See Sec. 601.601(d)(2)(ii)(b).
Although the 1998 proposed regulations and these notices provide
rules regarding many issues arising under section 529, other issues
remain unresolved. Current law regarding the transfer tax treatment of
section 529 accounts is unclear and in some situations imposes tax in a
manner inconsistent with generally applicable transfer tax provisions
of the Code. In addition, current law raises the potential for abuse of
section 529 accounts in certain situations.
Pension Protection Act of 2006
The Pension Protection Act of 2006 (Pub. L. 109-280, 120 Stat. 780)
(the PPA) permanently extended the EGTRRA amendments to section 529,
which previously were scheduled to expire at the end of 2010, including
the provision that exempts from Federal income tax distributions made
from section 529 accounts that are used to pay qualified higher
education expenses (QHEEs). See section 1304(a) of the PPA. At the same
time, section 1304(b) of the PPA enacted section 529(f). Section 529(f)
provides that, notwithstanding any other provision of section 529, the
Secretary shall prescribe such regulations as may be necessary or
appropriate to carry out the purposes of section 529 and to prevent
abuse of such purposes, including regulations under chapters 11, 12,
and 13.
In discussing new section 529(f), the Technical Explanation
prepared by the Joint Committee on Taxation provides two examples of
how present law creates the opportunity for abuse of section 529
accounts. See Joint Committee on Taxation, Technical Explanation of
H.R. 4, The ``Pension Protection Act of 2006,'' as Passed by the House
on July 28, 2006 and as Considered by the Senate on August 3, 2006,
(JCX-38-06), at 369. Abuse may arise because of the ability to change
designated beneficiaries (DBs) in certain circumstances without
triggering transfer tax. For example, taxpayers may seek to establish
and contribute to multiple accounts (taking advantage of the 5-year
rule of section 529(c)(2)(B))
[[Page 3442]]
with different DBs with the intention of subsequently changing the DBs
of such accounts to a single, common beneficiary and distributing the
entire amount to such beneficiary without further transfer tax
consequences. Abuse may also arise because taxpayers seek to use
section 529 accounts as retirement accounts, with all of the tax
benefits but none of the restrictions and requirements of qualified
retirement accounts.
Potential for Abuse of Section 529 Accounts
The IRS and the Treasury Department are aware of other situations
where current law raises the potential for abuse of section 529
accounts. For example, abuse may also arise if a person contributes a
large sum to an account for himself or herself and then changes the DB
to a member of his or her family who is in the same or a higher
generation (as determined in accordance with section 2651) as the
contributor. The contributor's contributions to his or her own account
would not trigger the gift tax because an individual cannot make a gift
to himself or herself. The contributor may claim that the subsequent
change of DB to a member of the contributor's family who is in the same
or a higher generation avoids the gift tax under the special transfer
tax rules of section 529. Abuse may also arise because contributions to
accounts are treated as completed gifts to the DB even though the
account owner (AO) may be able to withdraw the money at his or her
discretion.
Overview of Proposed Regulations
Section 529(f) authorizes the IRS and the Treasury Department to
promulgate regulations as needed to protect against these and other
types of abuse. Accordingly, the IRS and the Treasury Department intend
to issue a notice of proposed rulemaking to address the potential for
abuse of section 529 accounts. The notice of proposed rulemaking will
provide a general anti-abuse rule that will apply when section 529
accounts are established or used for purposes of avoiding or evading
transfer tax or for other purposes inconsistent with section 529. In
addition, the notice of proposed rulemaking will include rules relating
to the tax treatment of contributions to and participants in QTPs,
including rules addressing the inconsistency between section 529 and
the generally applicable income and transfer tax provisions of the
Code. The notice of proposed rulemaking also will include rules
relating to the function and operation of QTPs and section 529
accounts.
With some exceptions, the 1998 proposed regulations will be
reproposed in the notice of proposed rulemaking. The guidance published
in Notice 2001-55, Notice 2001-81, and the instructions and
publications related to Form 1099-Q, ``Payments from Qualified
Education Programs (Under Sections 529 and 530),'' also will be
included in the forthcoming notice of proposed rulemaking. Taxpayers
and QTPs may continue to rely on the information provided in existing
published guidance, including any effective dates therein. See Sec.
601.601(d)(2)(ii)(b) of the regulations. The IRS and the Treasury
Department anticipate that the forthcoming notice of proposed
rulemaking also will address additional comments that have been
received with regard to certain administrative, income tax, and other
issues affecting QTPs and section 529 accounts.
The IRS and the Treasury Department anticipate that the new rules
to be provided in the notice of proposed rulemaking will generally
apply prospectively to all section 529 accounts. Transition rules will
be provided if necessary. However, the anti-abuse rule may be applied
on a retroactive basis pursuant to section 7805(b)(3).
The IRS and the Treasury Department also anticipate that the notice
of proposed rulemaking may require some States (or agencies or
instrumentalities thereof) and eligible educational institutions that
have established and maintained QTPs to make changes to the terms and
operating provisions of their programs in order to ensure that their
programs remain qualified under section 529. The forthcoming notice of
proposed rulemaking will provide a grace period of no less than 15
months to implement most changes.
The following discussion sets forth the rules expected to be
included in the notice of proposed rulemaking and explains the
rationale for these rules.
Explanation of Provisions
I. Anti-Abuse Rule
The IRS and the Treasury Department are aware that the
inconsistency between the section 529 transfer tax provisions and the
generally applicable transfer tax provisions of the Code create the
potential for abuse of section 529 accounts.
As described above, the Technical Explanation accompanying new
section 529(f) provides two examples in which present law creates the
opportunity for abuse of section 529 accounts. Concern has also been
raised as to the potential for abuse in other situations. For example,
assume that in 2007, when the gift tax annual exclusion amount under
section 2503(b) is $12,000, Grandparents wish to give more than $1
million to Child, free of transfer taxes. Grandparents open section 529
accounts for each of their 10 grandchildren, naming Child the AO of
each account. Grandparents use the 5-year spread rule of section
529(c)(2)(B) to contribute $120,000 ($60,000 from each Grandparent) to
each grandchild's account without triggering any gift or generation-
skipping transfer (GST) tax liability. The earnings then accumulate on
a tax-deferred basis in the accounts and Child may withdraw the
balances at any time. If Grandparents survive for 5 years, the account
balances will not be included in their gross estates at death. In
effect, Grandparents have transferred $1.2 million to Child while
claiming that no transfer taxes are due and claiming to use none of
their applicable credit amount (formerly the unified credit). As
discussed more fully below, similar concerns have been raised where
there is a change from one AO to a new AO, thus giving the new AO all
rights to and control over the section 529 account, including the right
to completely withdraw the entire account for the new AO's benefit.
The forthcoming notice of proposed rulemaking will contain an anti-
abuse rule designed to prevent opportunities for abuse of section 529
accounts such as those set forth above. The anti-abuse rule generally
will deny the favorable transfer tax treatment under section 529 if
contributions to those accounts are intended or used for purposes other
than providing for the QHEEs of the DB (except to the extent otherwise
allowable under section 529 or the corresponding regulations). The IRS
and the Treasury Department anticipate that the anti-abuse rule will
generally follow the steps in the overall transaction by focusing on
the actual source of the funds for the contribution, the person who
actually contributes the cash to the section 529 account, and the
person who ultimately receives any distribution from the account. If it
is determined that the transaction, in whole or in part, is
inconsistent with the intent of section 529 and the regulations,
taxpayers will not be able to rely on the favorable tax treatment
provided in section 529. The anti-abuse rule will include examples such
as those set forth above that provide clear guidance to taxpayers about
the types of transactions considered abusive.
The IRS and the Treasury Department intend to monitor transactions
involving section 529 accounts. If concerns regarding abuse continue,
the IRS and
[[Page 3443]]
the Treasury Department will consider adopting broader rules including,
for example, rules limiting the circumstances under which a QTP may
permit AOs to withdraw funds from accounts; limiting the circumstances
under which there may be a change in DB; and limiting the circumstances
under which the AO may name a different AO. These rules may be adopted
in addition or as an alternative to the general anti-abuse rule.
II. Rules Relating to the Tax Treatment of Contributions to and
Participants in Section 529 Accounts
A. AO's Liability for Any Gift and/or GST Tax Imposed on a Taxable
Change of DB
Section 529(c)(5)(B) provides that the gift and GST tax apply to a
transfer by reason of a change in the DB of a section 529 account (or a
rollover to the account of a new DB) unless the new DB is both: (1)
Assigned to the same or a higher generation (determined in accordance
with section 2651) as the former DB, and (2) a member of the family of
the former DB. The statute does not identify the individual who would
be liable for the gift and/or GST tax in such a situation.
Section 1.529-5(b)(3) of the 1998 proposed regulations, in
accordance with the legislative history (H.R. Rep. No. 148 at 328),
provides that, if the AO changes the DB, or directs a rollover of
credits or account balances from the account of one beneficiary to the
account of another beneficiary, and if the new DB is not both a member
of the family of the former DB and in the same or a higher generation
(as determined under section 2651) as the former DB, the change of DB
by the AO is treated as a taxable gift by the former DB to the new DB.
This result follows from generally applicable transfer tax provisions
because each contribution to the section 529 account on behalf of the
former DB was treated as a completed gift to the former DB. As a
consequence, under the 1998 proposed regulations, the former DB is
deemed to be the owner of the funds contributed to the account and,
therefore, is the donor/transferor of the account to the new DB.
Because the AO rather than the DB has the power to change a
beneficiary, several comments on the 1998 proposed regulations raised
concerns about the imposition of tax on the former DB. In many cases,
the DBs are minors who may not be aware of the existence of the account
for their benefit.
The term ``account owner'' does not appear in section 529. The
definition of account owner in Sec. 1.529-1(c) of the 1998 proposed
regulations was included to reflect practices used at that time to
facilitate the establishment of accounts for minor beneficiaries. In
practice, the AO retains control over the selection of the DB and has
personal access to the funds in the account.
In order to assign the tax liability to the party who has control
over the account and is responsible for the change of any beneficiary,
the forthcoming notice of proposed rulemaking will provide that a
change of DB that results in the imposition of any tax will be treated
as a deemed distribution to the AO followed by a new gift. Therefore,
the AO will be liable for any gift or GST tax imposed on the change of
the DB, and the AO must file gift and GST tax returns if required. This
position comports with the income tax provision under Sec. 1.529-
3(c)(1) of the 1998 proposed regulations that treats a change of DB to
a new DB who is not a member of the family of the former DB as a
distribution to the AO, provided the AO has the authority to change the
DB. Special rules may be needed to address situations in which a trust
or an entity such as a bank, rather than an individual, is the AO. The
IRS and the Treasury Department welcome comments regarding such special
rules and on possible alternative approaches to collecting any transfer
taxes due upon a change of DB.
B. AO's Liability for Tax Imposed on Any Withdrawal by the AO From a
Section 529 Account for the AO's Own Benefit and on a Change in AO
Section 529(c)(3)(A) provides that, in general, any distribution
from a section 529 account is includible in the gross income of the
distributee in the manner provided under section 72, to the extent not
excluded from gross income under any other provision of chapter 1 of
the Code. Section 529(c)(3)(A) does not limit the class of potential
distributees.
As discussed previously in this preamble, the AO of a section 529
account is the party with control over the account. Concerns have been
raised regarding the potential tax consequences in situations where the
AO withdraws part or all of the funds from the section 529 account for
the AO's own benefit. For example, a contributor might attempt to avoid
gift tax by making contributions that do not exceed the gift tax annual
exclusion amount under section 2503(b) to multiple accounts having the
same AO. The AO could then withdraw some or all of those funds for the
AO's own benefit. The AO, as distributee, would claim to owe only the
income tax and a 10-percent additional tax on the earnings portion of
the withdrawal, while the taxpayer who contributed those funds would
claim to owe no gift or GST tax.
Concerns also have been raised regarding the possible tax
consequences in situations where an AO transfers control of the account
to a new AO, or names himself or herself (or the AO's spouse) as the
DB. The IRS and the Treasury Department expect to develop additional
rules to address these and other similar transactions by AOs, including
(1) limiting AOs to individuals; and, (2) making the AO liable for
income tax on the entire amount of the funds distributed for the AO's
benefit except to the extent that the AO can substantiate that the AO
made contributions to the section 529 account and, therefore, has an
investment in the account within the meaning of section 72. The IRS and
the Treasury Department welcome comments on such additional rules and
on any alternative approaches to preventing misuse by AOs of section
529 accounts.
C. Application of Transfer Tax Where Permissible Contributors to
Section 529 Accounts Include Persons Other Than Individuals
Under section 529(b)(1), a QTP is a program under which a person
may purchase tuition credits or certificates on behalf of a DB which
entitle the DB to the waiver or payment of QHEEs or, in the case of a
program established and maintained by a State or agency or
instrumentality thereof, may make contributions to an account which is
established for the purpose of paying the QHEEs of the DB of the
account. Section 1.529-1(c) of the 1998 proposed regulations provides
that, for purposes of section 529, the term ``person'' has the same
meaning as under section 7701(a)(1). Section 7701(a)(1) provides that,
when the term ``person'' is used in the Code and not otherwise
distinctly expressed or manifestly incompatible with the intent
thereof, the term shall be construed to mean and include an individual,
a trust, estate, partnership, association, company or corporation.
Since publication of the 1998 proposed regulations, this broad
definition of ``person'' has raised questions concerning the
application of the transfer tax and, in certain situations, the income
tax and the employment tax.
With respect to transfer taxes, section 529(c)(2)(A) provides that
any contribution to a section 529 account on behalf of a DB shall be
treated as a completed gift of a present interest in property to the
DB. Section 2501(a)
[[Page 3444]]
imposes a tax on the transfer of property by gift by an ``individual.''
Under Sec. 25.2501-1(a) of the Gift Tax Regulations, the gift tax is
not applicable to transfers by corporations or persons other than
individuals, except as provided in Sec. 25.2511-(1)(h)(1). Section
25.2511-(1)(h)(1) provides that a transfer of property by a corporation
to an individual is a gift to the individual by the stockholders of the
corporation. If the individual is a stockholder, the transfer is a gift
to the individual by the other stockholders to the extent it exceeds
the individual's own interest in such amount as a stockholder.
Because any contribution to a section 529 account is treated as a
completed gift, and because the gift tax is imposed only on
individuals, it can be argued that the definition of ``person'' in
section 529(b)(1) should be limited to individuals. Nevertheless, the
IRS and the Treasury Department believe it may be possible to interpret
sections 529(b)(1) and 529(c)(2)(A) consistently without limiting the
class of permissible contributors to individuals by providing special
rules for contributions made by corporations, partnerships, estates,
trusts, and other entities. For example, based on Sec. 25.2511-
1(h)(1), a contribution by a person other than an individual may be
treated as a separate gift by each beneficiary, member, shareholder,
partner, etc., in an amount representing that individual's allocable
share of the contribution.
Accordingly, the forthcoming notice of proposed rulemaking will
follow the 1998 proposed regulations in providing that the definition
of ``person'' as used in section 529(b)(1) will have the same meaning
as under section 7701(a)(1).
The IRS and the Treasury Department welcome comments on whether the
definition of ``person'' in section 529(b)(1) should be limited to
individuals and on rules necessary to ensure appropriate transfer tax
consequences in situations where persons other than individuals make
contributions to section 529 accounts. In addition, comments are
welcome as to whether the complexity of any special rules would
outweigh the benefit of allowing non-individual contributors.
Comments are also welcome regarding potential income tax
consequences when contributions are made by non-individuals, such as a
trust or estate, and whether the complexity of any special rules would
outweigh the benefit. For example, if a trust makes contributions to a
section 529 account, how should the trust treat the contributions to
and distributions from the account for income tax purposes? If the
trustee of the trust is the AO, would the income tax treatment be the
same?
The IRS and the Treasury Department also have considered the
possibility that employers may consider funding section 529 accounts
for employees' children or that a debtor may fund an account for the
lender's child. Section 529 does not override (or permit avoidance of)
federal taxes otherwise applicable to payments that are not in the
nature of gifts. The IRS and the Treasury Department believe that if
such contributions are made, all necessary procedures and reporting
mechanisms must be in place to ensure the assessment and collection of
all appropriate income, employment, and gift taxes. The IRS and the
Treasury Department welcome comments as to whether (and how) this could
be accomplished without undue burden.
D. Special Rules Apply in the Case of Individuals Who Contribute to
Section 529 Accounts for Their Own Benefit and in the Case of Uniform
Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA)
Accounts That Contribute to Such Accounts for the Benefit of Their
Minor Beneficiaries
The 1998 proposed regulations do not address situations in which
individuals contribute to section 529 accounts for their own benefit,
or where UGMA and UTMA accounts make contributions for the benefit of
their minor beneficiaries. (This situation should be distinguished from
a section 529 account established with the program as an UGMA or UTMA
account.) The IRS and the Treasury Department believe guidance is
needed regarding contributions by individuals for their own benefit and
by UGMA and UTMA accounts for the benefit of their minor beneficiaries
in order to ensure consistent tax treatment with section 529 accounts
set up by persons for the benefit of other DBs.
As stated in the previous paragraph, section 2501(a) imposes a tax
on the transfer of property by gift by an individual. Section
529(c)(2)(A) provides that any contribution to a section 529 account on
behalf of any DB shall be treated as a completed gift of a present
interest in property to the DB. A contribution to a section 529 account
by the contributor for the contributor's own benefit cannot be treated
as a completed gift because an individual cannot make a transfer of
property to himself or herself, and a transfer of property is a
fundamental requirement for a completed gift. Although there is no
express statutory intent to prohibit the funding of a section 529
account for the contributor's own QHEEs, the transfer tax provisions of
section 529 do not appear to contemplate such a result.
Minor beneficiaries of UGMA and UTMA accounts are the beneficial
owners of the accounts. In this respect, contributions to a section 529
account from an UGMA or UTMA account would be considered to be
contributions to the section 529 accounts by the minor beneficiaries
for their own benefit.
The IRS and the Treasury Department recognize that individuals may
want to save for their higher education expenses by contributing to
section 529 accounts and that individuals might not have parents or
other benefactors who are able or willing to make such contributions on
their behalf. The IRS and the Treasury Department also acknowledge that
section 529 accounts provide an efficient method for UGMA and UTMA
accounts to provide for the higher education expenses of their minor
beneficiaries.
Accordingly, it is anticipated that the notice of proposed
rulemaking will allow contributions to section 529 accounts by
individuals for their own benefit and by UGMA and UTMA accounts for the
benefit of their minor beneficiaries. In order to ensure consistent
transfer and income tax treatment under section 529 for these accounts
and accounts created by persons for the benefit of other DBs, special
rules will apply in cases of a subsequent change of the DB.
When contributors set up section 529 accounts naming themselves as
DB (or UGMA and UTMA accounts set up such accounts for their minor
beneficiaries) and subsequently change the DB, the change of DB from
the contributor to any other person will be deemed to be a distribution
to the contributor followed by a new contribution (as described in
section 529(c)(2)) of the account balance by the contributor to a new
section 529 account for the new DB. It is anticipated that the deemed
distribution to the contributor, followed by the new contribution of
the account balance to a new section 529 account for the new DB, will
be treated as a rollover (as described in section 529(c)(3)(C)) and
thus will not be subject to income tax or the 10-percent additional tax
imposed by section 529(c)(6) if the new DB is a member of the family of
the former DB. The new contribution by the contributor will be treated
in the same way for transfer tax purposes as all other contributions to
section 529 accounts under section 529(c)(2). If the change of DB in
these situations results in any gift and/or GST tax, the contributor
will be liable for the tax and must file gift and/or GST tax returns.
However, the contributor may elect to take advantage of the special 5-
year rule under section 529(c)(2)(B).
[[Page 3445]]
E. Circumstances Under Which the Account of a Deceased DB Will Be
Distributed to, and Includible in, the Gross Estate of the Deceased DB
for Estate Tax Purposes
Section 529(c)(4) provides that, with two exceptions, no amount
shall be includible in the gross estate of any individual for purposes
of the estate tax by reason of an interest in a section 529 account.
The exception relevant to this discussion is for amounts distributed on
account of the death of the DB.
Under section 529(c)(4)(B), amounts distributed on account of the
death of a DB are subject to estate tax. The legislative history (H.R.
Rep. No. 148 at 328) makes no reference to the term ``distributed'' but
provides that the value of any interest in a section 529 account will
be includible in the estate of a DB. Section 1.529-5(d)(3) of the 1998
proposed regulations adopts the position stated in the legislative
history. This position has raised several concerns because, under
generally applicable transfer tax provisions, the gross estate of a
decedent does not include property in which the decedent has no
interest, or over which the decedent has no power or control.
It is anticipated that the forthcoming notice of proposed
rulemaking will provide the following rules regarding the tax
consequences arising from the death of a DB.
Rule 1. If the AO distributes the entire section 529 account to the
estate of the deceased DB within 6 months of the death of the DB, the
value of the account will be included in the deceased DB's gross estate
for federal estate tax purposes.
Rule 2. If a successor DB is named in the section 529 account
contract or program and the successor DB is a member of the family of
the deceased DB and is in the same or a higher generation (as
determined under section 2651) as the deceased DB, the value of the
account will not be included in the gross estate of the deceased DB for
Federal estate tax purposes.
Rule 3. If no successor DB is named in the section 529 account
contract or program, but the AO names a successor DB who is a member of
the family of the deceased DB and is in the same or a higher generation
(as determined under section 2651) as the deceased DB, the value of the
account will not be included in the gross estate of the deceased DB for
Federal estate tax purposes.
Rule 4. If no successor DB is named in the section 529 account
contract or program, and the AO does not name a new DB but instead
withdraws all or part of the value of the account, the AO will be
liable for the income tax on the distribution, and the value of the
account will not be included in the gross estate of the deceased DB for
federal estate tax purposes.
Rule 5. If, by the due date for filing the deceased DB's estate tax
return, the AO has allowed funds to remain in the section 529 account
without naming a new DB, the account will be deemed to terminate with a
distribution to the AO, and the AO will be liable for the income tax on
the distribution. The value of the account will not be included in the
gross estate of the deceased DB for Federal estate tax purposes.
III. Rules Governing the Function and Operation of QTPs and Section 529
Accounts
A. Rules for Making the Election Under Section 529(c)(2)(B) To Treat
Contributions to a Section 529 Account as Being Made Over a 5-Year
Period
The IRS and the Treasury Department have received numerous taxpayer
inquiries regarding the operation of and the procedures for making the
5-year election provided in section 529(c)(2)(B). Section 529(c)(2)(B)
provides that, if the aggregate amount of contributions to a section
529 account during the calendar year by a donor exceeds the gift tax
exclusion amount for such year under section 2503(b), the donor may
elect to have the aggregate amount taken into account, for purposes of
section 2503(b), over the 5-year period beginning in such calendar
year. The forthcoming notice of proposed rulemaking will provide the
following rules that clarify the circumstances and manner in which the
election may be made.
Rule 1. The election must be made on the last United States Gift
(and Generation-Skipping Transfer) Tax Return (Form 709) filed on or
before the due date of the return, including extensions actually
granted, or, if a timely return is not filed, on the first gift tax
return filed by the donor after the due date. The election, once made,
will be irrevocable, except that it may be revoked or modified on a
subsequent return that is filed on or before the due date, including
extensions actually granted.
Rule 2. The election applies to contributions to a section 529
account on behalf of a DB during a calendar year that exceed the gift
tax exclusion amount for that year but are not in excess of five times
the exclusion amount for the year. Any excess may not be taken into
account ratably and is treated as a taxable gift in the calendar year
of the contribution.
Rule 2 is illustrated by the following examples:
Example A. Assume the contributor makes contributions to a
section 529 account on behalf of DB in 2007, when the gift tax
annual exclusion amount under section 2503(b) is $12,000. If the
contributor's aggregate contributions on behalf of DB in 2007 are
$30,000, contributor may elect to account for the gift as 5 annual
gifts of $6,000 to DB, beginning in 2007. Assuming the gift tax
annual exclusion amount remains at $12,000 over the 5-year period
covered by the election, the contributor could make additional gifts
described in section 2503(b) of up to $6,000 in each of the 5 years
to the same beneficiary without the imposition of any gift tax.
Example B. Assume the contributor makes contributions to a
section 529 account on behalf of DB in 2007, when the gift tax
annual exclusion amount under section 2503(b) is $12,000. If the
contributor's aggregate contributions on behalf of DB in 2007 are
$65,000, contributor may make the election under section
529(c)(2)(B) only with respect to that portion of the contributions
that is not in excess of $60,000 (5 x $12,000). The $5,000 excess
will be treated as a taxable gift by the contributor in 2007.
Rule 3. The election may be made by a donor and the donor's spouse
with respect to a gift considered to be made one-half by each spouse
under section 2513.
B. Income Tax Issues Related to Section 529 Accounts
The IRS and the Treasury Department have received numerous
inquiries relating to several income tax issues that will be addressed
in the forthcoming notice of proposed rulemaking. The following items
are illustrative of these inquiries and the IRS and the Treasury
Department anticipate addressing additional income tax matters raised
by comments.
The notice of proposed rulemaking will provide formal guidance on
how to recognize a loss in a section 529 account. Direction on this
issue was first provided in Publication 970 (Tax Benefits for
Education: For Use in Preparing 2002 Returns). Losses in section 529
accounts may be deducted as miscellaneous itemized deductions subject
to the 2% of adjusted gross income limit. Taxpayers will continue to be
able to rely upon this interpretation.
Section 529 is silent regarding whether distributions must be made
from a section 529 account in the same tax year as QHEEs were paid or
incurred. Concerns have been raised that individuals could allow the
account to grow indefinitely on a tax-deferred basis before requesting
reimbursement
[[Page 3446]]
or use distributions in earlier years to pay QHEEs in later years.
Accordingly, the IRS and the Treasury Department propose to adopt a
rule that, in order for earnings to be excluded from income, any
distribution from a section 529 account during a calendar year must be
used to pay QHEEs during the same calendar year or by March 31 of the
following year. The IRS and the Treasury Department welcome comments on
rules necessary to ensure that distributions from section 529 accounts
are appropriately matched to the payment of QHEEs.
C. Recordkeeping Requirements and Administrative Procedures
The forthcoming notice of proposed rulemaking may contain
recordkeeping requirements designed to facilitate the implementation of
these new rules, including the proposed anti-abuse rule. QTPs may be
required to collect and retain, and in some cases report to the IRS,
certain information. Programs may also need to revise their program
documents, administrative procedures, and promotional and required
literature for AOs and DBs. The forthcoming notice of proposed
rulemaking will provide a grace period of no less than 15 months to
implement most changes.
The IRS and the Treasury Department welcome comments regarding the
information that would be necessary to implement the proposed anti-
abuse rule, including a discussion of how to minimize the burden on
QTPs of collecting or reporting such information.
Request for Comments
Before the notice of proposed rulemaking is issued, consideration
will be given to any written comments that are submitted timely (a
signed original and eight (8) copies) to the IRS. All comments will be
available for public inspection and copying.
Drafting Information
The principal authors of this advance notice of proposed rulemaking
are Mary Berman of the Office of Chief Counsel (Passthroughs and
Special Industries) and Monice Rosenbaum of the Office of Chief Counsel
(Tax-Exempt and Government Entities). However, other personnel from the
IRS and the Treasury Department participated in its development.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E8-859 Filed 1-17-08; 8:45 am]
BILLING CODE 4830-01-P