Gift Tax Exclusion for Payment of Medical and Tuition Expenses

Under Section 2503(e) of the Internal Revenue Code (the “Code”), tuition payments made directly to an educational organization on behalf of a person, and payments for a person’s medical care made directly to the provider are not treated as taxable gifts. For example, grandparents who already take full advantage of the annual exclusion for gifts to grandchildren can make additional tax-free transfers by paying their grandchildren’s tuition for private school or college.

What education expenses besides tuition fall under the exclusion?

The education expense exclusion is limited to tuition. Tuition means the amount of money required for enrollment. It includes tuition for part-time students. It does not cover books, supplies, room and board or similar expenses. See Treas. Reg. §25.2503- 6(b)(2)(3). One issue, on which there appears to be no guidance, concerns institutions such as boarding schools which do not break out their fees between teaching expenses and room and board and instead charge one tuition fee. Some taxpayers claim the full fee charged by such an institution as qualifying for the Section 2503(e) exclusion. The IRS, at some point in the future, could challenge this.

Are there limits on the types of schools or educational organizations that qualify?

To qualify for the exclusion, the payment of tuition must be to an educational organization of the type described in Section 170(b)(1)(A)(ii). See IRC § 2503(e)(2)(A). Section 170(b)(1)(A)(ii) defines an educational organization as one that normally maintains a regular faculty and curriculum and has a regularly enrolled body of students in attendance at the place where the educational activities are being carried on. Treas. Reg. § 1.170A-9(b)(1).

Do private primary and secondary schools qualify? What about pre-schools?

The regulations under Section 170 specify that primary, secondary schools, high schools and colleges and universities all are considered “educational organizations”. The gray area concerns nursery or pre-schools. The inquiry is a fact-specific one. There is guidance in the form of public and private rulings. In Revenue Ruling 78-446, 1978-2 C.B. 257, the IRS ruled that a children’s day care center satisfied the definition of educational organization for purposes of exemption from certain taxes because it had a regular enrollment, planned educational activities, and instruction from a staff of teachers and assistants. Another day care program was found not to have educational activities as its primary purpose, where its function was more custodial in nature. Revenue Ruling 78-446.

Other providers of educational activities that have been found to qualify as educational organizations include a martial arts school, an instruction academy for yoga and a wilderness camping and survival program. The IRS concluded that the martial arts school’s primary function was the presentation of formal instruction, its courses were interrelated and given in a regular and continuous manner, thereby constituting a curriculum, it maintained a regular faculty, and had a regularly enrolled body of students. Rev. Rul. 78-309, 1978-2 C.B. 123.

For the organization providing yoga instruction and promoting the practice of yoga, the IRS was careful to distinguish its program of eight week yoga courses, which did qualify, and its other activities, which did not. Rev. Rul. 79-130, 1979-1 C. B. 332. Payment for the eight-week course presumably would qualify as a direct payment of tuition.

Payment for individual classes or other activities would not. In Revenue Ruling 83-140, 1983-2 C. B. 185, the IRS approved a wilderness company program for adolescents with emotional and behavioral problems. While this program lacked a traditional classroom setting, it had qualified instructors and an organized plan of instruction, which was taught during 26-day hiking and camping trips, repeated 10 months of the year. Based on this ruling, payments for certain types of summer camps, such as music, art or computer camps, also might qualify.

What medical expenses qualify for the exclusion?

Qualifying medical expenses are defined by reference to Code Section 213(d). See IRC § 2503(e)(2)(B). The exclusion applies to payments for (i) the diagnosis, cure, mitigation, treatment or prevention of disease, (ii) the purpose of affecting any structure or function of the body, or (iii) transportation primary for and essential to medical care. Treas. Reg. § 25.2503-6(b)(3). Payments for medical insurance are covered. The Section 213(d) definition of medical care is extremely broad. It also covers long-term care services, such as the costs of nursing homes or assisted living facilities, if provided by a licensed health care provider. The most notable area it does not cover is cosmetic surgery, unless to correct a birth defect or disfigurement from injury or disease. See IRC § 213(d)(9)(A).

What if the expenses subsequently are paid by health insurance?

If a donee’s medical expenses are subsequently reimbursed by insurance, the donor’s payment does not qualify for the exclusion. Treas. Reg. § 25.2503- 6(b)(3). The donee must reimburse the donor. If he or she does not, the donor’s payment will be treated as a taxable gift. The annual exclusion would apply to it if otherwise available.

Can I pay tuition or a doctor’s bill for a child or other relative by giving that person the money?

In the case of both educational and medical expenses, the payment must be made directly to the provider. This is a key element of the exclusion. If an individual gives her grandchild $5,000 to pay medical expenses, the gift does not qualify under Section 2503(e), even if the grandchild in fact uses the $5,000 for that purpose.

Are gifts using the exclusion subject to generation-skipping tax?

Transfers directly to the provider to pay tuition or medical expenses of a person, exempt from gift tax under Section 2503(e), are also exempt from GST tax. IRC § 2642(c)(3)(B).

Are 2503(e) transfers in addition to the gift tax annual exclusion?

Yes.

Robert Adler, Esq. is an attorney who focuses his practice on wills, trusts and estates. He can be reached at 212-843-4059 or 646-946-8327.