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Late-Stage College Planning

What are my options as a business owner?

As a business owner, you have unique college planning opportunities. If you are in a high tax bracket, it may be advantageous for you to shift assets or income to your child, who will typically be in a lower tax bracket. Generally, you can shift business income to your child using one of the following strategies:

  • Gift company stock to your child
  • Transfer a partnership or S corporation interest to your child
  • Arrange a gift-leaseback transaction with your child
  • Put your child on the company payroll

The common theme in all of these strategies is shifting business assets or income to someone in a lower tax bracket to  take advantage of lower tax rates.

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If you plan to sell appreciated company stock to pay for college, you may be able to shift the resulting capital gain into a lower tax bracket by gifting the stock to your child and allowing him or her to sell it. Your child can then use the sale proceeds to pay college expenses. There may be some tradeoffs, however.

First, the kiddie tax may limit your tax savings. Under the kiddie tax rules, a child's unearned income over a certain threshold ($2,500 in 2023) is taxed at parent income tax rates. The kiddie tax  generally applies to children under age 18 and full-time college students under age 24 whose earned income doesn't exceed one-half of their support.

Second, this strategy may have gift tax implications if the stock will be sold for more than the annual gift tax exclusion ($17,000 in 2023 for individual gifts and $34,000 for joint gifts).Third, this strategy might reduce your child's financial aid award. Under the federal government's methodology for determining financial aid, child assets (whether actual shares of stock or sale proceeds in a savings account) are weighed more heavily than parent assets. Accordingly, most college advisors recommend that your child hold few assets in his or her name as of the date the financial aid application is completed.

Fourth, it may be difficult to find a market for stock in your closely held business. A pre-arranged sale to another family member might be deemed a sham transaction by the IRS. But if the stock is sold to someone outside your circle of family and friends, your family may end up sharing ownership of the business with a stranger. Seek the advice of an attorney or  tax advisor when selling to a close family member so the transaction won't be considered a sham by the IRS.

If your business is treated as a partnership or S corporation for tax purposes, you may be able to shift income to your child by transferring an interest in the business to him or her. After you have transferred an interest in the business to your child, he or she can accumulate distributions of business income (unearned income) to cover college expenses. However, the kiddie tax may limit your tax savings and this strategy might reduce your child's financial aid award (as described in previous section).

Example(s): Anne owns a temp agency, and her business is set up as an S corporation. The value of the business is $400,000. Anne is the sole shareholder and is in the top tax bracket. Anne wants to start a college fund for her son Noah who is eight years old. Anne gifts $17,000 worth of nonvoting stock to Noah every year for 10 years (Anne will avoid federal gift tax by limiting her gifts to the annual gift tax exclusion amount). During the early years, Noah will receive dividends on the S corporation stock that can accumulate to cover his college costs. However, Noah's tax savings will also be limited due to the kiddie tax rules.

However, the IRS has rules governing who is eligible to be a shareholder in an entity treated as an S corporation for tax purposes. Consult with an attorney or tax advisor to be certain that making your child a shareholder of your S corporation will not jeopardize the corporation's tax treatment. In addition, to be recognized as a partner in a partnership, your child must have the capacity to enter into a partnership contract in your state. Generally, your child must have reached the age of majority or acted through a duly authorized guardian, conservator, or trustee. Consult an attorney or tax advisor who is familiar with the laws of your state.

In addition, there are costs associated with this strategy. An attorney must draft a partnership agreement. Documents and tax returns must be filed. Appraisals must be made. Transfers must be documented, and appropriate titling instruments prepared. Further, if a trust is recommended, trust documents must be drafted. Consider these expenses when evaluating your potential tax savings. In the case of an S corporation, you will need a corporate attorney to handle the transfer of stock and, if needed, the issuance of nonvoting shares.

A gift leaseback is a transaction in which one party gifts property to another party and then leases the property back. The discussion here focuses on  a parent/business owner using a gift-leaseback arrangement to transfer an asset to a child in order to reduce the family's overall federal income tax liability.

In a gift-leaseback transaction, the typical strategy is to give a substantial business asset (e.g., a building, land, equipment) directly to your child or to an irrevocable trust for the benefit of your child. A trust is often used when parents are uncomfortable gifting a substantial asset directly to their child. You then enter into a fair market lease with your child (or the trust) to lease the asset back. Your child receives income from the lease payments, and you can deduct the lease payments as a business expense.

Example(s): Dr. Robinson has a successful medical practice and owns the medical building in which he practices. He is in a high tax bracket. He has a young child for whom he has would like to start a college fund. Dr. Robinson could gift the building to an irrevocable trust for the benefit of his child. He could then lease the building back from the trust at a fair market rental. These payments "flow through" the trust to the child.

The main benefit of a gift-leaseback from parent to child is that parents can divert income (in the form of lease payments) from themselves to their child, who is probably in a lower income tax bracket. The child can then use this money (and the resulting tax savings) to save for college. And assuming the gift-leaseback transaction is structured properly, parents can deduct the lease payments as a business expense.

The main drawback of a gift-leaseback is that child assets are counted more heavily than parent assets for purposes of financial aid and you (the donor) may owe gift tax depending on the value of the asset being gifted to your child. If the value of the gift is less than the annual gift tax exclusion amount ($17,000 for individual gifts or $34,000 for joint gifts in 2023), you will avoid federal gift tax. If the gift is more than this amount, you may owe gift tax (but any gift tax owed may be offset by your applicable exclusion amount).

Also, keep in mind that the IRS pays close attention to gift-leaseback transactions to determine if such transactions are in fact genuine, that is, based on prevailing market values and rental rates. This is especially true for transactions between related parties like parent and child. This means that a qualified independent appraiser should be used to determine both the fair market value of the asset being gifted and what a fair market rental should be for that asset. In addition, there should be a written lease agreement with standard terms for that type of property. One of the provisions of the lease should be a penalty provision for breaches of the agreement, such as a specified penalty for late lease payments. These attributes signify to the IRS that the gift-leaseback transaction is not a sham.

If you give the asset to a trust instead of directly to your child, the trustee of the trust should be independent from you and other family members. Parents should also avoid naming their attorney or accountant as the trustee. Preferably, the trustee should be completely independent (for example, a bank or an independent fiduciary). Also, if a trust is used, it should not contain a provision allowing the property to come back to you at some point in the future (called a reversionary interest). If there is such a provision, the IRS may not consider this arrangement to be a true gift, in which case the lease payments would not be deductible.

And there are some tax consequences to keep in mind. As mentioned, if the gift-leaseback is structured properly, the parent can fully deduct the lease payments as an ordinary and necessary business expense (assuming that the leased asset is used in the parent's trade or business). However, the child must report the lease payments as income, but depending on the asset acquired, he or she may be able to claim depreciation deductions with respect to the asset and offset some of the lease income. Finally, as noted previously gift tax may be due depending on the value of the asset being gifted. Consult an attorney or tax advisor for more information or for help in implementing a gift-leaseback.

You may be able to shift income into a lower tax bracket by putting your child on your company's payroll. Your child can work in the family business, receive a weekly paycheck, and accumulate money for college.

Example(s): Dan owns a closely held business and is in the top tax bracket. He hires his daughter Molly to work in the family business. Like other employees, she receives a weekly paycheck. She works 15 hours per week at $12 per hour and earns $180 per week. At the end of 50 weeks, Molly earns $9,000. Because she is in a lower tax bracket, Molly will have more money available to put toward college than if Dan had earned that $9,000.

Check the child labor laws in your state to determine at what age, and for how many hours, your child may legally work. Also beware that if you pay your child more than a reasonable amount of compensation, the IRS may deem the excess a gift.

This strategy has several strengths. First, the kiddie tax does not apply because this income is earned income as opposed to unearned income. Second, gift tax does not apply because your child is earning his or her own income. third, your child will be eligible to open an IRA because he or she will have earned income. Fourth, a child under age 18 who works for his or her parents in a trade or business will not owe Social Security or Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. And finally, by working in the family business, your child  gains practical work experience and may learn some transferable skills However, as discussed above, if your child is seeking financial aid,  this strategy could reduce his or her award because child assets are counted more heavily than parent assets in the federal government's financial aid formula. If your child has substantial savings from working at the family business, one option is to have your child open an IRA, which is not counted as an asset for financial aid purposes by either the federal government or colleges. Also, withdrawals from an IRA that are  used for college expenses aren't subject to the early distribution penalty.

What are creative solutions to help pay for college?

Saving money, borrowing money, and financial aid are the most obvious ways to pay for college. But none of these methods attempt to lower the actual cost of college. There are seveal creative ways to lower the cost of college, which, in turn, will lower your own costs.

Defer enrollment

Many colleges will accept your child for admission in the future -- maybe in a year or two. Instead of heading straight to college after his or her high school graduation, your child can work full-time to earn money to apply to the future college bill.

Consider accelerated programs

If the college allows it, your child may be able to obtain a bachelor's degree in three years instead of four or a five year bachelor's-master's degree. This way, you'll save a year's worth of expenses. The drawback is that your child will have to take a heavier course load each semester and may have to forgo summer breaks.

Enroll in a community college, then transfer to a four-year institution

Many students live at home to attend a local two-year community college for basic level courses and then transfer to a four-year school for their final two years. In nearly all cases, the community college will be less expensive than the four-year college and can save you money for two years. The benefit is that your child receives a diploma from the four-year college that does not announce that your child spent the first two years at a community college. Of course, you should make sure that the four-year college will accept for credit the community college courses.

Take special academic exams

Your child may be able to earn college credits for basic courses before he or she even gets to college. This is accomplished by taking courses or tests designated as advanced placement (AP) or as college level exam program (CLEP). This saves money by cutting down on the required college course load. Make sure the college accepts the test before your child takes it.

Consider a co-op education

Some 900 colleges now allow students to alternate semesters of education with semesters of full-time work in a field related to their majors. A co-op degree usually takes about five years, a full year longer than the typical college education. However, not only will your child have a history of relevant work experience to present to potential employers after graduation, but also he or she will earn a paycheck while working.

If you're considering withdrawing money from your traditional IRA or Roth IRA to pay for college, you'll want to evaluate several factors:

  • How many years you have until retirement
  • Your retirement balances
  • The amount of money you intend to withdraw
  • Whether you have other sources of money available
  • The tax consequences of a withdrawal

Both traditional IRAs and Roth IRAs allow you to withdraw money before age 59½ for a child's college expenses without incurring the federal 10% early withdrawal penalty that normally applies to early withdrawals. As for income tax, Roth IRA withdrawals are typically tax free (if certain requirements are met) because Roth contributions are made with after-tax dollars (which means they have already been taxed). However, you'll need to carefully consider the income tax consequences if your contributions to a traditional IRA were deductible. In this case, the amount you withdraw will be added to your taxable income for the year you withdraw it. This could be enough to put you in a higher tax bracket.

If you are close to retirement, look carefully at the impact of any withdrawal; a large withdrawal could alter your plans. Even if you aren't close to retirement, it may take years for you to replace those lost funds, so think carefully before doing so.


As you send your child off to college, you probably have a lot of things on your mind, such as whether your child will eat right and get enough sleep, how to pay tuition, and what to do with that empty bedroom. And although insurance may seem like a low priority, there are some important issues you should consider.

As for health insurance, even if your child isn't a student, the Patient Protection and Affordable Care Act requires your medical plan to extend dependent coverage for your adult child up to age 26. But if the plan is an HMO and your child's college is far from home, accessing an approved provider may prove difficult. An alternative is to purchase health insurance coverage through your child's college. Many colleges and universities offer low-cost health insurance for students. However, be sure to check the maximum coverage limits on school-subsidized health insurance carefully. They are generally much lower than your own policy, which is one reason the college plan is less expensive.

If your child will be living in a dorm or other university housing, his or her personal property will typically be covered under your homeowners insurance policy. However, you may want to check your policy for coverage limitations on certain items (e.g., computers and stereos). If your child moves out of the dorms and into an apartment, his or her personal property will usually no longer be covered under your policy. In that case, he or she should purchase a renters insurance policy to cover his or her possessions.

If your child will be taking a car to school, make sure that the car is properly insured. If the child owns the car, the insurance policy must be in his or her name. If the child is "borrowing" a family car, he or she must be listed as a driver on the insurance policy. Some insurance companies may require the child to be listed as the primary operator, since the car is in the child's possession and not the parents'.

Direct payment of tuition to an educational institution is not considered a taxable gift. Therefore, you're able to "give away" more than $17,000 per year (the annual federal gift tax exclusion) for your grandchild's college education and not worry about gift taxes. However, colleges may reduce a student's institutional financial aid by the amount of your payment. So before sending a check, ask the college how it will affect your grandchild's eligibility for college-based aid.

With 529 plans, all contributions are considered gifts, so the federal gift tax exclusion comes into play. This exclusion lets you gift up to $17,000 per year per person (in 2023) without any gift tax or estate tax consequences. There is one exception. Under special rules unique to 529 plans, you can gift up to five times the annual gift tax exclusion — $85,000 in 2023 — and avoid gift tax if you elect on your tax return to treat the gift as if it were made evenly over a five-year period. Married grandparents can gift up to $170,000 this way. (Keep in mind that even if you go over these limits, you won't necessarily owe gift tax. You must first use up your lifetime applicable exclusion amount before you'll have to pay gift tax out-of-pocket). Grandparents must also be aware of the generation-skipping transfer tax, or GSTT, which is a tax imposed on a gift made to someone who is more than one generation below you.

Regarding financial aid, grandparent-owned 529 accounts do not need to be listed as an asset on the federal government's financial aid application, the FAFSA. However, withdrawals from a grandparent-owned 529 plan must be reported as student income, which has the potential to cut a student's aid award in half the following year because student income is assessed at 50% by the FAFSA. To avoid having a withdrawal from a grandparent-owned 529 account count as student income, one option is for the grandparent to delay taking a withdrawal from the 529 plan until after January 1 of the grandchild's junior year of college because there will be no more FAFSAs to submit. Another option is for the grandparent to contribute to a 529 account owned by the parent.

Note: Starting with the 2024-2025 FAFSA (which will be available October 1, 2023), distributions from grandparent-owned 529 plans will no longer be counted as student income. Students won't be required to report any type of cash support.

529 plans offer an advantage over the direct payment of tuition: tax-free withdrawals from a 529 plan can be used to pay for items besides tuition, including room and board, books, and supplies.

You should also consider the possibility that you may not live long enough to pay your grandchild's tuition in the future. If such a case, any general funds will be part of your taxable estate, and  the money your grandchild needs for education may not be available after settling your estate. But if you contribute to a 529 plan now, your contributions are considered present interest gifts and are generally taken out of your estate. (An exception exists if you elect to spread a lump-sum gift over five years and you die during the five-year period. In that case, the portion of the contribution allocated to the years after your death will be included in your gross estate.)

Note: Before investing in a 529 plan, please consider the investment objectives, risks, charges, and expenses carefully. The official disclosure statements and applicable prospectuses, which contain this and other information about the investment options, underlying investments, and investment company, can be obtained by contacting your financial professional. You should read these materials carefully before investing. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated. Investment earnings accumulate on a tax-deferred basis, and withdrawals are tax-free as long as they are used for qualified education expenses. For withdrawals not used for qualified education expenses, earnings may be subject to taxation as ordinary income and possibly a 10% federal income tax penalty. The tax implications of a 529 plan should be discussed with your legal and/or tax professionals because they can vary significantly from state to state. Also be aware that most states offer their own 529 plans, which may provide advantages and benefits exclusively for their residents and taxpayers. These other state benefits may include financial aid, scholarship funds, and protection from creditors.

Financial aid for college can consist of loans, grants, scholarships, and work study. Grants and scholarships are preferable because they don't have to be repaid. There are three sources for grant aid: colleges, the federal government, and state higher-education agencies. College grants may be either need-based or merit-based, and they can range from a few thousand dollars up to the full cost of education. Federal and state grants are based on financial need and are much lower.

In order to be considered for any type of need-based college grants, you'll  need to file the federal government's financial aid application, the FAFSA. In addition, private colleges typically require the PROFILE form, or their own individual aid form, along with the FAFSA.  Even if you don't think your child will qualify for need-based grants, you should consider filing these forms anyway because some colleges may require them before your child be considered for merit grants.  Keep in mind that families must reapply for financial aid every year.

College grants

College grants have the most potential to significantly lower the cost of attendance. Many colleges offer specialized grant programs; this is particularly true of older schools with many alumni and large endowments. College grants are typically based on financial need or scholastic or athletic ability. You can use a net price calculator, available on every college website, to get an estimate of how much grant aid your child might expect at a particular college based on his or her financial and academic profile.  College grants are worth exploring because in many cases they make up the majority of a student's grant aid. Consult a college's admission or financial aid office for  more information about grants offered at the college, including selection criteria and necessary applications, and use various net price calculators to compare your out-of-pocket cost at different colleges after grant aid is factored in.

Federal grants

There are two main federal grants for college: Pell Grants and Federal Supplemental Educational Opportunity Grants (FSEOGs). Both are based on financial need and are relatively small amounts.

The Pell Grant program is the government's largest financial aid grant program. Pell Grants are available to undergraduate students with exceptional financial need and are the foundation of every undergraduate student's financial aid package (for those who qualify). Graduate students are not eligible. Pell Grants are administered by the federal government and awarded on the basis of college costs and financial need. Financial need  is based on factors such as family income and assets, family size, and the number of college students in the family. For the 2022-2023 academic year, the maximum Pell Grant is $6,895.1

The FSEOG is the federal government's second-largest grant program. An FSEOG is available to undergraduate students who demonstrate the greatest financial need (i.e., those students with the lowest expected family contributions). Priority is given to Pell Grant recipients. The FSEOG is a campus-based program, which means that the financial aid office at each college administers it. Every college receives a certain amount of FSEOG funding from the federal government each year, and when the funds are awarded, there are no more until the following year. So even though  a student might be eligible for an FSEOG based on his or her financial need, the funds may have already been expended for that year. The maximum FSEOG award is $4,000 per academic year, and awards can range from $100 to $4,000.

State grants

Many states offer grant programs as well. Each state's grant program is different, but many give special preference to state residents planning to attend an in-state school. For more information, contact your state's higher-education agency.

    • U.S. Department of Education, 2022

You should start by filling out the federal government's aid application, the FAFSA. This application is used by both the federal government and colleges when federal money is being dispersed.

The best way to fill out and submit the FAFSA is online at the Department of Education's website at In order to do so, you and your child will first need to obtain an FSA ID, which you can also do online.

The FAFSA relies on current asset information and income information from two years prior (e.g., the 2023-2024 FAFSA  relies on your 2021 income tax return). The FAFSA has the ability to directly import your tax information using the IRS Retrieval Tool, which is built into the form. The FAFSA can be filed as early as October 1st in the year prior to the upcoming school year. For example, for the 2023-2024  school year, you can file the FAFSA starting October 1, 2022.

Regarding college financial aid, colleges generally require both the FAFSA and the PROFILE form (or their own aid form in place of the PROFILE). The PROFILE can also be filled out and submitted online. Make sure to find out which application your child's college requires and make a note of all filing deadlines. Deadlines can vary depending on whether your child is a new student or a returning student and whether your child is applying early decision/early action or regular decision.