Do you like taxes? Do you like taxes on gifts you’d like to make to your grandchildren? Do you have an oddly misplaced hatred for charities? No? Neither do we. Good news – we can help, at least when it comes to paying for your grandchildren’s (and/or their children’s, and their children’s …) school and medical expenses.
About Health and Education Exclusion Trusts (HEETs)
The HEET allows a donor to create a trust to provide for educational and medical benefits of skip persons (defined below) over extended periods of time, including beyond the lifetime of the grantor, such as grandchildren or a remote lineal descendant, on a non-Generation Skipping Transfer (GST) tax basis. Although no allocations of GST exemption are made to the HEET, the HEET is structured so that the funding of the trust, and ultimate distributions from the trust, are not subject to GST tax. This is because the distributions for the benefit of skip persons (a person that is two or more generations below the grantor’s generation, or 37½ or more years younger than the grantor) are paid directly to an educational organization or medical care provider on behalf of the beneficiary, which is not a taxable distribution.
A key feature of a HEET is to ensure that the HEET itself is not considered a skip person. If all the beneficiaries are skip persons, then transfers to the HEET would be considered direct skips, subject to the GST tax. This otherwise taxable transfer is avoided by providing that at least one of the beneficiaries is not a skip person, in this case, by designating a charity described in IRC Section 2055 as a current beneficiary of the HEET.
The charitable beneficiary or beneficiaries can be selected by the donor or left to the discretion of the trustee. In order to ensure that the charitable beneficiary has a valid interest in the trust and the trust is not considered a skip person, the charity must have a present, nondiscretionary right to receive income or principal from the trust. Typically, the charitable beneficiary has a designated percentage of the annual trust income, such as 10-20%. Whatever the amount, the IRS has instructed that the charitable beneficiary’s interest must be of a “meaningful” amount. There is no strict rule regarding the amount of distributions to be made to charitable beneficiaries in order for such distributions to be considered meaningful, although the more significant the charitable interest is, the greater the likelihood the IRS will find it meaningful.
As a note:
- Education payments must be paid directly to the educational institution for the beneficiary’s tuition. Pre-payments of tuition are also allowed. The tax-free treatment does not apply to payments for room and board, books, fraternal organizations, transportation, etc.
- Medical payments are for qualifying medical expenses only. These include: medical care expenses (including diagnosis, cure, mitigation, treatment, or prevention of disease), transportation and certain lodging expenses necessary for such care; and health insurance. Tax-free treatment is not allowed for items that are reimbursed by insurance or for medical treatment for cosmetic purposes (except to correct disfigurement due to birth defect, accident, or disease).
- The grantor is not required to file a gift tax return as a result of making qualifying payments of tuition and medical expenses.
So, if you have some young, up-and-comings and a charity or two that you could you imagine yourself benefiting, you’ve come to the right place. Feel free to give us a call anytime! We do this all day long, folks. 303.793.3400.
Updated Dec. 2021