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How to Begin
Gifts of up to $11,000 a year to individual children or grandchildren cause no legal or tax complications for either the donor or the recipient. In fact, a couple with sufficient means can bestow $22,000 annually on each child and grandchildwith no tax liability. In the future, these amounts will be indexed for inflation. However, giving larger amounts to one individual or placing restrictions on a gift requires special planning.
There are various reasons why you might want to give more or restrict access to your gift. You may, for example, want to reduce your estate taxes. Or, if you're in a high tax bracket, you may be able to move some investment income to a minor who is taxed at a lower rate. Restrictions may be advisable to keep money out of a youngster's hands until he or she is mature enough to use it wisely.
Fortunately, there are strategies that enable you to achieve most of the objectives you have in mind without penalty and with potentially beneficial results.
The "Uniform Transfers to Minors Act"
The Uniform Gifts to Minors Act, which almost all states adopted, recently was superseded in many states by the Uniform Transfers to Minors Act (UTMA). The new legislation enables you to transfer virtually any type of property to a minor: real estate, limited partnership interests, patents, etc. A UTMA account is simple and inexpensive to establish, but in making such a gift, it is wise to check the law as it applies in the state you reside for the exact language necessary to avoid difficulties later.
The donor parent or grandparent normally should not be custodian of the gift, because, should the donor custodian die before the child receives the funds, the gift would be taxable in the donor's estate. Instead, someone else should be named. In addition, remember that gifts made to a UTMA account qualify for the $11,000 annual gift tax exclusion.
One disadvantage is that the recipient is entitled by law to the UTMA property upon reaching age 18 or 21, depending on the state in which the account is created. Thus, if you want to delay receipt of the gift until the child is older, a UTMA account is not the right vehicle.
The "Kiddie Tax"
Income of up to $750 produced by a gift is tax free to a child under the age of 14 because it is offset by the $750 standard deduction. The next $750 is taxed at the child's marginal rate of 15 percent. All income of more than $1,500 is taxed at the parent's marginal rate - called the "kiddie tax" because it is meant to restrict the shifting of income by the parent to the child's much lower tax bracket in order to avoid taxes. Nevertheless, tax savings can be achieved, even with the kiddie tax, as the chart below illustrates.
When the child reaches the age of 14 all income is taxed at the child's rate. There can be only one beneficiary for each UTMA. Therefore, assets cannot be commingled for investment purposes if several children are involved.
When To Consider A Trust
As noted, a UTMA account won't work well if the donor wants to postpone use of a gift beyond the date when the child reaches age 18 or 21. If this is of concern to you, you might consider using a trustespecially in situations where a large amount of assets is involved.
With three notable exceptions, a gift to a trust for the benefit of a minor does not qualify for the $11,000 annual gift tax exclusion because it is not a gift of a present interest.
Internal Revenue Code 2503(c) does allow gifts to qualify if they meet the following requirements:
- The principal and income of the trust must be available for the child's benefit during the term of the trust. (This means it must be availablenot that it actually be paid out.)
- The child must be given the right to a full distribution when he or she reaches the age of 21. However, an IRS Revenue Ruling allows the trust to continue after the beneficiary reaches age 21 if the beneficiary does not exercise his or her right to withdraw the trust corpus within a specified period of time.
A 2503(c) Trust allows the trustee to commingle the assets of several such Minor's Trusts into a single investment portfolio. One professional portfolio manager can be hired at less total expense than if the trusts' assets are managed separately. For example, grandparents who want to set up equal shares for four grandchildren and fund them with annual exclusion gifts totaling $88,000 would find this device advantageous.
Another type of Minor's Trust, the 2503(b) Trust, has an agreement that mandates distribution of income to the minor on an annual basis. A portion of gifts made to such a trust will be deemed a present interest and will qualify for the $11,000 annual exclusion. The remaining portion is deemed a future interest and will not qualify. It is a taxable gift and would use a portion of the donor's unified credit.
A third type of trust gives the minor the right to withdraw the $11,000 annual contribution to the trust. The gift to the trust is considered a gift of a present interest even if the funds are not withdrawn. This is sometimes called a "Crummey" withdrawal right, named after the case which upheld the concept. The remaining provisions of the gift trust could contain delayed distribution or other desired features. The income from this type of trust is taxed to the child.
You may simply set aside investments earmarked for a minor and not make the gift until the child reaches a certain age or is deemed capable of handling the property. This provides the donor with the most control, but all income is taxed to the donor. The assets and any appreciation remain in the donor's estate until the gift is made.
There is no limit on the gift tax exclusion in the case of funds that are paid directly to an educational or medical institution or provider. Moreover, this exclusion is in addition to the $11,000 annual exclusion for other gifts.
How to Find Out More
If you're interested in additional information regarding gifts to minors or would like to learn more about trust and financial services offered by Northern Trust, we'd be happy to help.
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