Ins And Outs Of Asset Transfers To Minors

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Reprinted From: Delaware Business Review
Written By: Nancy F. Blumberg, CPA-PFS, CFP
To provide for your child or your grandchildren's future educational costs, or just to provide the child with a nest egg, you may wish to transfer assets to a minor. You might even be motivated by the estate, gift and income taxes that could be saved as a result of the gift. There are many ways to transfer ownership of assets to minors.

The easiest way to transfer property to a minor is to transfer the asset to the child's name. This transfer is usually undesirable because it may be difficult for the minor to sell the property based on the general law of contracts. Alternatives to such outright transfers are the use of guardianships or custodianships. Guardianships involve court appointed guardians that manage property for minors. They are expensive and are usually used when minor children are orphaned and trusts have not been established for property left to them.

Custodianships are created under the Uniform Gift to Minors Act (UGMA) and the Uniform Transfer to Minors Act (UTMA). As a donor you may transfer money, securities, and insurance contracts under the UGMA. Under the UTMA, which has been adopted in several states, you may also transfer real and personal property, partnership interests and other property interests.

Transfer of property under the UGMA and UTMA allows the donor to retain control of and handle the property for the benefit of the child. It does not require any legal document. Accounts established under UGMA or UTMA should bear the child's social security number. The assets placed in the account qualify for the annual gift tax exclusion and the gift is irrevocable at the time of the transfer. When the minor reaches majority (which differs from state to state) all property must be delivered to the child.

In some states, as in Delaware, although the age of majority is 18 you can specify that the account be maintained until the child reaches age 21.

Generally, income earned on UGMA accounts is taxed to the child. However, if the income is issued to discharge a legal obligation of someone else, such as the child's parent, the income will be taxed to that person. Some states consider college education to be an item of support. For example, in New Jersey, college is a support item while in Delaware it is not. This will affect the taxation of the income earned on a UGMA account. The main advantage to a UGMA account is its simplicity, low cost and ease of administration. There are potential disadvantages including its inflexible distribution requirement at age of majority, inability to transfer certain assets to such accounts, questionability of education as a support item and loss of the parents' control over assets if the parent is not the custodian.

When you want to transfer assets to a minor child you should explore the use of trusts. Trusts provide an opportunity to meet your objectives since they are very flexible and can be structured to provide for your needs.

Also, there is no restriction on the types of property that can be transferred to a trust. The Tax Reform Act of 1986 significantly limits the income tax benefits of trusts for children under age 14, but there are still income tax benefits to be derived. Trusts continue to be advantageous for estate planning purposes.

When transferring property to a trust it is usually important for the gift to qualify for the annual gift tax exclusion. In order for a gift to qualify, it must be a gift of a present interest. This means that the donee must have the present right use, possess or enjoy the property. Therefore, the trust must be carefully drafted to provide for this present interest.

The Internal Revenue Code provides for several types of trusts which qualify as gifts of a present interest. One of these trusts is a Sec. 2503 (c) trust. To comply with Sec. 2503 (c) the principal and the income from the trust must be available for distribution while the donee is under age 21; accumulated principal and income must be distributed when the donee reaches 21; and if the donee dies before reaching 21 all principal and income must be paid to either his estate or to the donee's appointee. In effect, this statute waives the present interest rule for donees under the age of 21 who use this type of trust.

In Sec. 2503 (b) Trust, the trust income must be distributed annually to the donee. The trustee can be given the discretion to make distributions of principal while the donee is a minor.

The principal may be distributed to the beneficiaries at a prescribed age after majority or the donee can demand portions of the principal at certain ages. Since this type of trust is considered to have a present interest and a remainder interest, only the present interest qualifies for the annual gift tax exclusion. The donor would use a small part of the unified estate and gift tax credit to transfer the remainder into the trust.

A Crummy Power trust, named after the Ninth Circuit Case Crummey v. Commissioner, tries to circumvent the restrictive provisions of Sec. 2503 (c) & Sec. 2503 (b) trusts. It neither requires the distribution of principal at age 21 nor the mandatory annual income distribution. The Crummy Power gives the beneficiary the power to demand the trust property, when transferred to the trust for a specific period of time, i.e. 30 days. The IRS has conceded that if the beneficiary has a sufficient withdrawal period and the beneficiary is a given notice of this right gift will qualify as one of present interest. Therefore, the Crummy Trust provides the donor with more flexibility in his planning.

As discussed, the trust provisions are very technical.

They do, however, provide protection and limited control over assets with great flexibility. It is important to seek advice from your tax advisor when planning gifts to minors.