If you own a family business, investment or income property, you may have a flexible and ready source of funds to pay for a college education.
John Camp, a real estate broker and developer from Potomac, Maryland, uses at least one of his properties to generate money his 15-year-old daughter and 12-year-old son will be able to use to pay for college. The children are employed on a working farm near the Chesapeake Bay that Camp and his wife bought as an investment. The money that Camp pays his children goes directly into their college savings. Not only do the children work for their education kitty, Camp gets a tax break because his company can deduct their wages, which range up to $5,000 a year and will increase as the children get older.
Camp's approach to college funding illustrates the opportunities for anyone who owns investment properties or a small business.
It's all legitimate and offers even more savings for children whose families may not qualify for financial aid due to high income.
``The children are paid through our company that owns the farm, which is a limited liability corporation,'' Camp says. ``Then their salaries are deposited into a bank account. The plan is that they will have fully funded educations.''
On the farm
For now, Camp's children do light work on the farm and their salaries are low. His son cuts the grass and his daughter drives a tractor on the 30 acres where they grow soybeans, corn and barley. Camp expects that the children may draw as much as $15,000 in annual pay when they're older.
With tuition at private universities costing about $40,000 a year, the income the Camp children earn probably won't be enough to cover the entire expense.
For that reason, Camp says he supplements his kids' college savings funds by contributing $10,000 a year to the College Savings Plan of Maryland, a state-sponsored 529 plan that compounds money tax free for college expenses.
State savings plan
Camp and his wife each contribute $5,000 to the Maryland program, which puts them under the annual federal gift-tax limit of $11,000. By investing in their state's plan, they also can take the maximum Maryland income-tax deduction of $2,500 each per child. Note that state tax incentives vary widely. They range from nothing in states with no income tax to generous -- up to $20,000 per joint return in Mississippi.
"I'd rather do it now,'' says Camp of his funding plan, "it's a way of creating forced savings.''
Camp's adviser, John Pearson, a certified public accountant and college planning specialist in Norwalk, Connecticut, says small business/property owners do best with their funding strategies if they know they will not qualify for financial aid in the future.
"This works best for people with incomes above $125,000,'' Pearson advises, noting that if a family has a chance at obtaining financial aid, it's best not to have money in a child's name. That can hurt chances for aid.
Businesses can not only pay children salaries for things like office chores, cleaning and basic computer work, but the children also can earn rental income from the family business.
For example, a child can be given fully depreciated office equipment as a gift, which can then be leased back to the company. This creates an income stream for the child, who then puts aside the money for college.
This arrangement has a couple of advantages. For one, the child will be in a lower tax brackets than the parents. The lease payments also are a tax-deductible expense for the business.
Children also can use their salaries to fund Individual Retirement Accounts, the proceeds of which can be withdrawn without penalty for college expenses.
Pearson says that the best business structure for a college-funding strategy is the limited liability corporation, especially when children are under age 18.
"A single owner is treated like a self-employed person for tax filing purposes,'' Camp adds. "And there is no Social Security tax required to be withheld or matched by the employer- parent.''
You do have to be careful about how much you pay your children. Pay them too much and the Internal Revenue Service will be knocking on your door. To get an idea of how much children should earn, Pearson suggests you check with a local temporary help agency and ask what rates they pay for various jobs.
Changing tax laws
Keep in mind that a cloud is hanging over the present tax laws that may make this strategy obsolete.
The President's Tax Reform Panel planned to issue a report on Sept. 30 that might have proposed dropping the relevant tax deductions. The report probably will be delayed because of Hurricane Katrina.
While it's not known what's in the report -- and Congress is unlikely to act on the panel's findings this year -- keeping in touch with your CPA or tax planner is a wise move.
In the meantime, consider ways of creating income from your family business for your children. It may even be a good time to start a family firm.
Depending on how much they make, your children may not pay any taxes and be able to increase their own savings years before heading off to school. Saving early and often is an education in and of itself.
Wasik is a columnist for Bloomberg News