Nonindividual QTP Contributions

RC section 529 qualified tuition programs (QTPs) provide a tax-favored way to invest for qualified higher education expenses (QHEEs). While individuals usually contribute to benefit family members, nonindividuals also may contribute. Thus, employers may wish to fund QTPs as fringe benefits for employees. CPAs should understand the myriad tax issues.

PURPOSE
Taxpayers at all income levels can make contributions to QTPs. Section 529(b)(6) limits contributions to amounts needed to provide for a designated beneficiary’s QHEEs (some state programs provide for lesser dollar amounts).

Earnings accrue tax-free under section 529(c)(1) and distributions are tax-free under section 529(c)(3)(B)(i) when used to pay for a designated beneficiary’s QHEEs. Section 529(e)(1)(A) requires beneficiaries to be identified when QTP participation commences, though in certain cases, this decision can be postponed.

TAX RAMIFICATIONS
When a person other than an employee (such as a worker’s son or daughter) is a QTP’s designated beneficiary, plan contributions are deemed completed gifts from the employee to the beneficiary under section 529(c)(2)(A)(i), eligible for the section 2503(b) annual gift tax exclusion ($11,000 for 2004). Contributions in excess of this limit can be averaged over five years under section 529(c)(2)(B).

Employer contributions. There is no specific guidance on the treatment of employer contributions to QTPs for employees. Under one scenario transfers are completed gifts to a designated beneficiary but, under section 102(c), transfers by or for an employer to, or for the benefit of, an employee are not excludible from income as gifts. Because section 529 generally requires the designated beneficiary to be identified when participation begins, and because the employee would choose the beneficiary, contributions to QTPs made on an employee’s behalf would be deemed compensation to him or her under section 3401.

Assuming immediate vesting (so that the employee is treated as the account owner immediately), a cash-basis taxpayer and an arm’s-length transaction, the contribution would be both ordinary income to the employee and a completed gift to the designated beneficiary in the year paid. The employer would deduct the contribution in the year paid or accrued as a section 162(a) ordinary and necessary business expense. These contributions also appear to be taxable fringe benefits subject to section 3402(a) income tax withholding, and wages subject to Social Security and Medicare taxes.

RECOMMENDATIONS
Employer contributions to QTPs may be attractive for closely held corporations. First, they may provide a way to deal with excessive compensation issues, as long as fringe benefits are treated differently from salary and wages. Second, if family members also are employees, this may allow income shifting to relatives with lower marginal tax rates. However, vesting issues and other restrictions also apply.

For more information see “QTP Contributions by Nonindividuals” in the November 2004 issue of The Tax Adviser.

—Lesli S. Laffie, editor
The Tax Adviser