In my article last month, I discussed general tax considerations in making gifts. Here we touch on a specialized situation—gifts to minors. There are a number of non-tax factors that encourage gifts to minors.
A parent may want to provide a child with experience in handling money. A mistake made while young could provide a valuable example for later life. A grandparent may want to see a grandchild get some early enjoyment of part of a later inheritance. A parent may wish to begin providing for the retention or orderly transfer of control in a family business. If the business is increasing in value, the estate tax eventually due may be substantial, and lifetime gifts can ease this burden. Of course, you likely don’t want your 8-year-old granddaughter serving on the board of directors. A gift of a family business interest to a minor is typically made in trust or in the form of an interest that does not have voting power.
Gifts of income-producing property can help provide for the support and education of the donee, although income used from property gifted by a parent to support a minor will probably be taxed to the parent. This would not, however, be the case for items that are not viewed as required support, such as college education (at least if the child is over 17).
From a tax standpoint, the parent’s motive may be, in part, to remove post-gift income and appreciation from the estate. Income tax savings may be more problematic. Aside from the discharge of a support obligation mentioned above, donors also must consider the impact of the “Kiddie Tax,” which provides that unearned income (e.g., interest and dividends) of a person under age 24 will be taxed at the parent’s rate if, as is usually the case, that rate is higher than the child’s.
My last article discussed the transfer tax benefits of annual exclusion gifts. Individuals can make gifts of $13,000 ($14,000 in 2013) per donee without incurring any gift tax. Thus, a couple could make non-taxable gifts of $54,000 per child between now and the end of 2013 without having to pay any gift tax. Such gifts occur outside the gift and estate tax regime altogether. Donors can make a very substantial reduction in their estates rather quickly by making gifts to dependents and their spouses.
There is, however, the natural fear that an immature person will squander an outright gift. But if the gift has strings attached, and cannot be spent immediately, it may not be eligible for the annual exclusion. The rules that allow the exclusion require that the donee receive what is called a “present interest.” This means that the donee must receive an immediate economic benefit, or at least have the opportunity to acquire an immediate benefit. A gift made to a trust where income is accumulated and not distributed for several years would be a gift of an unqualified “future interest.”
This tension between the concern about youthful improvidence and the desire for favorable tax treatment is ameliorated by certain provisions of the Internal Revenue Code. These rules can be complex and they have many variations. In the simplest form, the annual gift tax exclusion will apply if the gift is made to a custodian of a minor donee under the Uniform Transfers to Minors Act. The Virginia Act allows the transferred property to be retained and invested by the custodian (who may be the parent) until the child reaches age 21, even though 18 is the age of majority.
But even 21 can seem too young for many donees. It may be preferable to transfer assets to a trust that will last until the child reaches a more mature age. Fortunately, the Code allows qualifying gifts to be made in trust. It does require that if a child survives to age 21, he or she must receive the accumulated income and principal at that time, or at least must have access to the assets. There is no rule, however, that the property cannot continue to be held in trust if the child does not demand distribution. The trust can even provide that, if the child has not exercised the authority to demand distribution within a specified period of time after reaching age 21, the trust will continue until the child reaches a more mature age without disqualifying the original gifts to the trust from the annual exclusion. The trust can provide that the child has, for example, 30 days after reaching age 21 to direct payments or else the trust will continue until she reaches age 30. Moral and financial pressure on the child may dissuade him or her from exercising this right to demand distribution, but each family and each child’s situation and temperament will be different.
It is important to take both tax and non-tax considerations into account when making gifts to minors. A little bit of careful planning can help ensure that a gift is used for the purposes for which it was intended.
Ted Troland is an attorney with Glenn Feldmann Darby & Goodlatte – visit www.gfdg.com to learn more.