Gifts to Minors: Outright, Per the UTMA, or in Trust?

Outright gifts to minors pose the fewest tax problems, but may not always accord with the donor’s desires. While an indirect gift may be made to a legal guardian who manages the property for the child, court appointment and annual accounts to the court are required. Moreover, indirect gifts, to qualify for the annual exclusion, must comply with the Crummey rules which though less onerous than generally perceived do rise to the level of a nuisance.

Gifts made under the Uniform Transfers to Minors Act (UTMA) are held by a custodian who manages the property until the minor reaches the age of majority, which in New York is age 21. Making the gift is simple: securities, bank accounts, tangible personal property and real estate need only be titled to the “[custodian] for the benefit of the [minor]”. No other documentation is required; nor are annual accountings necessary. The UTMA custodian has broad management powers over the property. She may distribute or accumulate income or principal as she determines appropriate for the minor’s benefit. The IRS has ruled that UTMA transfers qualify for the annual gift tax exclusion, which means that up to $20,000 (exclusive of discounts) can be transferred by parents who split gifts. The child must file a 1040 reporting UTMA income (whether or not distributed), but no fiduciary return need be filed. The two principal disadvantages to UTMA gifts are that (i) the property must be distributed outright when the child attains the age of 21, and (ii) children under 14 are subject to income tax at their parents’ rate on all unearned income over $500.

The donor may insist on greater control over gifted property, and in that circumstance a trust must be used. The IRC §2503(c) trust is attractive, since contributed property qualifies for the annual exclusion. However, fiduciary returns must be filed, and a tax identification number obtained. While the taxation of trust distributions at parents’ tax rates may be avoided by withholding distributions, trust income in excess of $4,000 is now taxed at 31%; that in excess of $8,350, at 39.6%. Therefore, even if modest tax savings could result by withholding trust distributions, the fiduciary returns would grow correspondingly more complex, and overall savings would likely be small.

Although the IRC §2503(c) trust also requires complete distribution of trust assets when the beneficiary reaches the age of 21, the regulations permit the beneficiary to elect to extend the trust term for any length of time. The trust may even provide that the trust term will be extended unless the beneficiary withdraws the trust funds within a reasonable period after his or her 21st birthday. The beneficiary must, however, know of the existence of this provision. The donor of property should not be chosen as the trustee of an IRC §2503(c) trust: estate tax inclusion could result under IRC §§ 2036 or 2038 if the donor predeceased the donee, by reason of the trustee’s retained powers to control trust distributions.

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