Stingier on student loans, US still offers tax goodies

Every parent has a rich uncle who will help pay college costs. The uncle's name is Sam. While many families are unaware of it, government aid for education is not limited to loans. With proper structuring of a family's financial affairs, the government will take a smaller tax bite out of parents' income. The tax savings can provide cash to pay the cost of college education.

"It makes sense for Sam to pay for education through tax savings," says Herbert Paul, associate national tax director at Touche Ross & Co.

Help in paying college costs is needed now more than ever. this year the average cost of a four-year private college is $6,885, with the tab at many Ivy League schools running in excess of $11,000.

At the same time costs are rising the government is getting stingier with loan funds. On Oct. 1, a ceiling was placed on the income a family could have and still quality for a federally guaranteed loan.

Even if a family can qualify for federal loans, is still should make maximum use of tax-saving devices. For while loans must be repaid, tax savings are "free," since they put cash in family coffers tht otherwise would have to be sent to Washington.

Although several tax saving strategies are easiest for rich families to adopt , at least one effective technique -- the interest-free loan of a student -- also works for middle-income parents. "This approach is open to parents of mare modest means," notes James J. Guildea, tax partner in th Boston office of Arthur Adersen & Horwath.

The student should invest the funds from his parents at the highest possible rate. Tax advisers suggest using a money market mutual fund. Treasury bill, of money market certificate at a bank or saving institiution."You should try to get something with the highest possible yield with safefy," says Mr. Paul

Because they pay a reduced interest rate, All-Savers certification are not a ggod investment vehicle for you in the interest free loan strategy.

Tfhe strategy "is not blessed by the IRS," notes Mr. Cunningham. But he reports that the IRS has lost court battles over the issue. The most notable loss was the 1978 "Crown" case in tax court, which was later upheld by the Seventh Circuit Court of Appeals. The decision held that an interest-free loan between family members was tax free.

o have protection under the Cown decision, the loan to a child must be evidenced by a legally enforceable note saying the obligation is payable on demand. The child must not be old enough to enter into a legal contract. And the agreement between the parties cannot spell out a specific repaymment schedule.

Once risk in the interest-free plan approach is that a child could take the loan proceeds and abscond with them."When a kid wants a yellow Corvette, that money is gone," Gildea says.

For protection, the parent may require dual signatures on withdrawal of the loan funds or have the security the child buys with the loan fund placed in the parent's safe deposit box. Other method of protection -- including formation of a trust -- can be designed by a bank trust officer or tax advisor.

"This is not for everyone," Gidaea cautions, "Anyone with a question or doubt should consult a tax adiviser."