Gifts to Minors: How to Prefer Your Children and Grandchildren Over Uncle Sam
Several gifting vehicles are available to help preserve the family treasure
The annual gift tax exclusion, currently in the amount of $11,000 per donee, is a valuable tool in implementing estate plans because it is a renewable resource. Each year parents, grandparents or other donors may make gifts of $11,000 to as many donees as they wish, transfer tax free. Moreover, married couples can pool their exemptions and gift up to $22,000 per donee per year, provided that they file gift tax returns confirming their intent to “split the gift.” Such gifts are also exempt from the reach of the generation-skipping transfer tax.
The cumulative effect of annual gifts, particularly when the appreciation of the gifted property in the hands of the donee is taken into account, can achieve significant estate tax savings. Moreover, when gifts are coupled with discounting techniques, such as family limited partnerships or other leveraged planning techniques, such as irrevocable life insurance trusts, the savings can be greatly enhanced. Donors must take caution, however, not to unintentionally exceed the amount of their annual gift tax exclusion by overlooking the many possible forms such gifts can take.
Special considerations apply when the intended beneficiary of the gift is a minor. Rarely do parents or other donors feel comfortable making outright gifts to minors. Rather, they want to manage and control the gifted funds for the benefit of the minor until he or she has matured and can responsibly handle large sums of money. These concerns pose a problem because the annual gift tax exclusion only applies to gifts of a present interest, and absent an exception to this rule, gifts made to a trust or other account for the benefit of a minor will not qualify for the gift tax exclusion.
Many parents and grandparents make gifts for the benefit of minors without understanding the full range of options available to them or the implications of their acting as trustee or custodian of the gifted funds.
Uniform Gifts or Transfers to Minors Acts (UGMA & UTMA)
The most commonly used vehicle for gifts to minors are accounts established at banks and brokerage houses pursuant to state statutes, the Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). These accounts are easily established by checking a box on the account application thereby invoking the provisions of the statute with regard to the management and disposition of the funds. The custodians of the funds are given broad powers to manage the funds and either accumulate and reinvest them or pay or apply them for the minor beneficiary as the circumstances dictate. Generally, income is taxable to the minor and no separate income tax return is required from the custodian.
Most donors wish to remain in control of the funds by acting as custodian. However, if the donor acts as custodian and predeceases the donee, the gifted property will be included in the donor’s gross estate, thus defeating the purpose of the gift. In addition, if a parent acts as custodian and makes distributions to pay for expenses that are his or her legal obligation, they are deemed to be taxable income to the parent. For these reasons, it is best to choose a custodian other than the beneficiary’s parents.
Both UGMA and UTMA require that the funds be turned over to the beneficiary upon his or her attaining majority. Many donors feel that 18 or 21 is too young an age to receive substantial funds and would prefer that they be administered until the beneficiary attains 25, 30 or 35 years of age.
Named after the Internal Revenue Code section that expressly qualifies such a trust for the annual gift tax exclusion, a 2503(c) trust must meet the following requirements:
- the trust principal and income must be available for distribution while the beneficiary is under 21
- all accumulated income and principal of the trust must be distributed to the beneficiary when he or she attains 21, and
- if the beneficiary dies before attaining 21, all income and principal must be paid either to the beneficiary’s estate or to one or more beneficiaries pursuant to a general power of appointment exercised by the donee beneficiary
Once again, the donor of a 2503(c) trust should not serve as trustee for estate and income tax reasons. However, a non-donor parent can act as trustee, even if he or she splits the gift with the donor parent. The income is taxable to the trust, which is a separate taxpaying entity, unless it is distributed to the beneficiary.
Although it is one of the three requirements that a 2503(c) trust terminate and be distributed to the beneficiary upon attaining age 21, it is possible to give the beneficiary notice that the trust has terminated and that he or she has the right to withdraw the principal and accumulated income, but provide that if the beneficiary chooses not to do so that the trust will continue until the beneficiary attains 25, 30 or some other designated age. After the child attains age 21, the trust becomes a grantor trust and all income is taxed to the beneficiary.
A “Crummey Trust” takes its name from a case decided decades ago, which established the concept that giving the trust beneficiary the right to withdraw the gifted property would convert the gift from a future interest to a present interest, thereby qualifying it for the annual gift tax exclusion under Section 2503.
It is essential that the trustee of a Crummey Trust give notice of any gifts received to the beneficiary’s parent and that such notices are maintained so that they can be produced in the event of future IRS inquiry. The income of the trust is taxable to the beneficiary.
529 Plan Account
A new and increasingly popular form of gifting for minors are accounts established pursuant to Section 529 of the Internal Revenue Code to provide for the beneficiary’s educational expenses.