Grandparents can give their grandchildren the gift of a college education and receive a little something back themselves from Uncle Sam. However, education tax breaks often do not apply to grandparents because they fail to meet the requirements for dependency. Instead, grandparents are more likely to avoid just gift taxes by paying for a grandchild's tuition bill.
The Internal Revenue Service allows grandparents to deduct tuition payments for grandchildren if they can claim the student as a dependent. In general, the grandparent must pay for half the child's expenses, and the student must be younger than 24 at the end of the year. If the student takes a personal exemption, only he can take an education tax break, regardless of how much the grandparent pays for tuition.
An education tax break has additional requirements the grandparent must meet other than dependency of the student. For instance, in 2011, a taxpayer cannot claim the American Opportunity credit if he makes more than $80,000 a year, or $160,000 for joint filers. If the grandparent makes between $65,000 and $80,000, the tax credit or deduction phases out. For the tuition tax deduction, the taxpayer can deduct only $2,000 in expenses if his income falls within the phaseout range.
If the grandparent does not qualify to take an education tax break, she can always avoid gift taxes by contributing to the child's educational expenses. The IRS lets parents give children $13,000 a year tax-free as of 2011, but if the grandparent pays the college directly she can contribute an unlimited amount of money that does not affect the annual or lifetime limit to the gift tax exclusion.
If grandparents want to contribute to their grandchild's education and receive a tax break, they should set up a 529 plan for the child. States often give the payer on a 529 savings plan a tax deduction -- if the state levies an income tax. However, the grandparents and the parents should review the Federal Application for Student Aid and anticipate how a gift will affect a financial aid package. Savings plans, for instance, count as an asset if it is in the child's name and probably reduce his financial aid package.