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Paying Tuition Directly Avoids Gift-Tax Exclusion Limits

The gift-tax exclusion rose to $13,000 for 2009 (it had been $12,000), a modest increase that may be welcomed by those who give annual gifts to relatives or help out with others’ education or medical expenses. 

It’s easy enough to set up a 529 college savings plan, open a Coverdell Education Savings Account or use a Uniform Transfers to Minors Act (UTMA) account to save for higher education. There is, however, an easier way, if you can afford it, and if you don’t have time to invest for long term. 

The recipient can be a relative or a friend, and you won’t run afoul of the gift-tax exclusion. 

IRS Publication 950 makes it clear that if your gift qualifies for the educational or medical exclusion, it is not a taxable gift. To do this, you simply pay education (or medical) expenses directly and forget about the gift –tax exclusion, because the amount is unlimited. 

The key is to send your payment directly to a “qualifying” institution. Whether it’s a private high school, a college or a hospital, you must send the money directly to the institution. As long as you do that, the IRS takes no interest.