Making Gifts to Minors

Quite often annual exclusion gifts will be made to minor children or grandchildren as part of someone’s estate plan. In some instances, these gifts may create problems for the donor and donee. First, there are restrictions on a minor’s ability to hold or otherwise deal with property under applicable state law. Second, the donor will naturally be concerned about the safety of the funds if the minor has significant access rights. Third, if you make a gift to anyone where there are restrictions on the ability to get access to the gift, then the gift can be considered a gift of a future interest and does not qualify for the $11,000 annual exclusion amount. However, there are several methods for making annual exclusion gifts to minors with restrictions on the minor’s access to the property that will still allow the gift to be considered a gift of a "present" interest, meaning it does qualify for the $11,000 annual exclusion. These exceptions are as follows:

1. Uniform Transfers to Minors Act (UTMA)

The UTMA statute (formerly the “Uniform Gifts to Minors Act” or UGMA) is a set of model laws that have been adopted in various forms in individual states, Texas included. They permit the transfer of funds to a custodial account for the benefit of a minor. The custodian of the UTMA account manages the property under the rules provided by state law. The custodian is to use the assets during the child’s minority for support, education, and maintenance of the minor. In most states, the custodianship terminates when the child reaches 21; however, in some states, the age at which the minor must receive the property is 18. Under UGMA, investments were generally limited to money, securities, life insurance, and annuity contracts, although some states allowed investments in other assets. Under UTMA, property that can be transferred includes any property, real or personal, tangible or intangible. Transfers may be made during lifetime and from trusts, estates and guardianships, regardless of whether the governing instrument authorizes such transfers.

Income on the assets is taxable to the minor, whether distributed or accumulated. Children under 14 pay tax at parents’ top tax rate on unearned income over $1,000. Donors should note, however, that if a donor appoints himself or herself custodian, the assets will be part of the donor’s estate should he or she die before distribution to the minor occurs. To remove the asset from possibly being included in the donor’s gross taxable estate, a third party should be named as custodian for the account.


2. Section 2503(c) Trust.

A Section 2503(c) trust is another type of irrevocable trust designed to receive annual exclusion gifts for a minor. It derives its name from the Section of the Internal Revenue Code that allows a gift to such a trust to be counted against the $11,000/year annual exclusion amount. The trust is allowed to accumulate current income prior to the termination of the trust.

a. Requirements:

(1) The Trustee may expend principal and income for the minor before he/she reaches age 21.

(2) Any principal and income not expended will pass to the minor when he reaches age 21.

(3) Should the minor beneficiary die prior to age 21, the principal and accumulated income will be paid to his estate or to whomever he appoints.


3. 529 Plans.

One of the great benefits currently available are Section 529 college plans, which allow parents (or grandparents) to set up a college fund for their children or grandchildren without any taxable consequences. While a full detailed discussion of the plan is not feasible for this post, the basic set-up is that a tax-free contribution of up to $55,000 in any one year can be made to an account for the future benefit of a designated person. The only caveat is that it must be used for educational purposes (tuition, books, fees, etc.). It is allowed to grow tax-free and is distributed at the time the student attends college, with no income-tax consequences upon distribution. If that student does not use the entire amount, or dies before the time the funds are used, then an alternative beneficiary (i.e., another student in the family) can be named for those funds. If it winds up that the assets are distributed back to the creator of the account, then it will be taxed to the recipient at ordinary income tax rates along with a 10% penalty. If the creator of the account dies before the assets are distributed, there are no estate-tax consequences, because the assets are not includable in the account creator’s estate.

Donors should also note that beyond the 529 plans anyone can make tuition payments for private schools or for public or private universities and also for medical expense payments on behalf of anyone without the tuition or medical payments being considered gifts. The tuition payments must be made directly to the school or university, and cannot be given to the parent of the student. The exclusion also only covers tuition payments—not room and board or books. Similarly, the medical payments must be made directly to the medical provider or insurer rather than to the person who incurred the medical expense. Grandparents often find these two exclusions as a great way to make gifts without incurring gift tax.

Before you make a gift to or for the benefit of a minor, make sure you are not running afoul of any gift tax rules. Also, make sure that the minor child is not someone who will be able to handle receiving the property at an early age. If not, you should consider other alternatives for the future distribution of the assets, e.g., through an irrevocable trust that lasts beyond the age of 21. You should also get legal advice from someone experienced in the estate planning area to make sure that you are not creating a problem either for the minor recipient of the gift or for yourself. A little planning on your part can help provide substantial benefits in the future for the recipient of your gift.