Restrictions on Section 529 plans

Aug. 1, 2004
My 13-year-old daughter has over $20,000 in her Uniform Gift to Minors Act (UGMA) account to help pay for future college costs. Currently, these funds are all invested in stock mutual funds.

Charles Blair, DDS, and John McGill, MBA, CPA, JD

My 13-year-old daughter has over $20,000 in her Uniform Gift to Minors Act (UGMA) account to help pay for future college costs. Currently, these funds are all invested in stock mutual funds. Can I transfer these mutual funds tax-free into a Section 529 college savings plan?

No. Section 529 plans do not allow individuals to contribute securities or mutual funds directly into the account, only cash. As a result, the custodian would need to sell the mutual funds, and then transfer the cash into the Section 529 college savings plan.

Any gain on the sale would be measured by the difference between the sales proceeds, less the amounts contributed into the stock mutual fund and all reinvested dividends and capital gains. If the sale occurs in the calendar year in which your daughter will turn 14, the federal capital-gains tax rate may be as low as 5 percent on the sale. If not, the regular 15 percent maximum tax rate on capital gains will apply.

Switching to a Section 529 college savings plan at your daughter's age may actually result in very little, if any, tax savings, especially when compared to the additional fees and expenses involved. Beginning at age 14, all income earned by a child (including capital gains, dividend and interest from custodial accounts) will be taxed to the child at the child's tax rate (maximum 5 percent tax rate on capital gains and dividends; the balance will be taxed at rates as low as 10 percent).

Moreover, if the child pays for college from his or her own funds, from gifts, distributions from a custodial account, or a family limited partnership (FLP), or limited liability company (LLC), the child is eligible to claim the education tax credits (HOPE/Lifetime Learning) on his or her own tax return. This will effectively eliminate federal income taxes for most children during their four years of college. As a result, we would recommend that you carefully review the cost and benefits of selling these custodial account assets and moving the funds into a Section 529 plan before making the move.

I recently incorporated my dental practice and would like my corporation to buy a new business car for me. I was planning to trade in my personal car in order to reduce the cost of the new car to the corporation. Do I need to transfer the title into the corporation before I make this transaction?

We would recommend a different strategy in order to produce better tax results for you, individually, and for your professional corporation. Transferring your personally-owned car into the corporation would involve some transfer taxes, fees, and other costs. In addition, through the trade-in, the amount of future depreciation benefits on the new auto will be limited to the additional amount paid for the car by the corporation.

Alternatively, we would recommend that you simply sell your personally owned automobile and pocket the proceeds tax-free. The corporation should purchase the business car using 100 percent financing, with repayment over a five-year term. In this manner, you will be able to enjoy the tax-free proceeds from the automobile sale personally, while your professional corporation is allowed to deduct the entire cost of the business car over time. Furthermore, 100 percent financing the car purchase and spreading repayment over a five-year term minimizes the cash-flow impact to the corporation, allowing you to maintain funds necessary for retirement plan funding and other practice purposes.

I purchased some stock on January 15 of last year and sold it on January 15 of this year for a huge gain. I understood that if I held the stock for at least one year, I would be eligible to claim the lower capital-gains tax rates on the proceeds from the sale. My accountant disagrees. What's going on here?

Unfortunately, you are laboring under a common misconception. Section 1222 of the tax law requires that stocks, bonds, and real estate be held for more than one year in order to be eligible for the maximum 15 percent tax on long-term capital gains. Since you held this stock for only one year, your gain does not qualify. Thus, you will be subject to tax at ordinary rates of up to 35 percent on the gain from this transaction.

Dr. Blair is a nationally known practice-profitability consultant and a member of the American Academy of Dental Practice Administration. Mr. McGill is a tax attorney, CPA, and MBA, and is the editor of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes, and protect assets. The newsletter ($199 a year) and consulting information are available from Blair/McGill and Company, 2810 Coliseum Centre Drive, Suite 360, Charlotte, NC 28217, call (704) 424-9780 or visit the Web site at

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