How to Make Gifts to Minors

Written By: Attorney Jeffrey A. Marshall, CELA*  

This article describes several methods you can use to make lifetime gifts to your children or grandchildren who are under age 18. Your gifts to minors do not generate any income tax deduction, but they can reduce your potential estate tax and they do avoid gift tax if they do not exceed $10,000 in value per recipient per year.

Gifts to minors may be made either outright to the minor or by one of several protected methods. An outright gift to a minor may be unsatisfactory both because minors usually cannot transact financial business (other than handling a simple bank account) and because many minors lack the judgment and experience to manage their own financial affairs. Here are three common methods to make protected gifts to minors:

Custodianship
You can create a custodianship by designating an adult as custodian for the minor to receive gifts under the Pennsylvania Uniform Transfers to Minors Act. The custodian can then control the management of the gifted property and determine whether or not to make distributions for the minor until the minor attains age 21. At age 21, the minor must receive whatever property is held by the custodian. Its simple to create a custodianship. Any bank, broker or mutual fund will help you set up a custodial account. For income tax purposes, the custodianship property belongs to the minor, and the minor must file income tax returns. No tax returns need be filed by the custodian.

2503(c) Trust
This is trust that continues until the minor reaches age 21. At that age the trust must either terminate automatically or the minor must be given the right to withdraw all of the trust property from the trust during a 60-day "window." You may provide that, if the minor does not withdraw the trust property, the trust will continue for a further period specified in the trust instrument. The 2503(c) trust offers the following advantages over a custodianship: (1) the trust's income is taxable to the trust rather than to the minor, which may be advantageous for minors under age 15, whose income may be taxable at the parent's tax rates; and (2) the trust is "on track" to continue beyond the minor's 21st birthday unless the minor elects to withdraw the trust property. For income tax purposes, the trust is a separate taxpayer with a taxpayer identification number (similar to a Social Security number), and the trust files its own income tax return each year.

Crummey Trust
A third method of making gifts to minors also involves a trust, sometimes referred to as a "Crummey trust." (Use of a Crummey trust is not limited to minors and may be used for gifts in trust for a beneficiary of any age.) The unique characteristic of this trust is that any time you give property to the trust, the minor (or the minor's guardian) must have the right to withdraw the contribution during a 30 or 60 day window. If the minor does not withdraw the trust property, the gift becomes final and is locked in the trust until the trust terminates at the age you specified when you set up the trust. The Crummey trust offers the following advantages: (1) although the minor has a right to withdraw any contribution, this right is rarely if ever exercised; and (2) unlike the custodianship and 2503(c) trust, the minor has no right at age 21 to receive the property, and the trust continues for as long as specified in the instrument (even for the minor's lifetime). For income tax purposes, this trust is treated more like a custodianship than a 2503(c) trust. Although the trust is a separate taxpayer with a taxpayer identification number and files a simple "grantor" tax return, the trust's income tax consequences flow to the minor, who must file income tax returns.

While giving money or investments to a child may seem like a smart move, there are many issues to consider. It is true, there can be income tax savings, especially if the child is over age 14, and assets are removed from your taxable estate. But transferring money to the child may make it more difficult for the child to get financial aid (including loans) for college expenses. The formulas for determining aid require the child to contribute as much as 35% of his or her assets per year, while parents can be required to pay up to only 5.6% of theirs. And a grandparent's assets have no impact at all. This means a sizable custodial account can limit the financial aid the child will receive. If the child is not going to qualify for college financial aid in any event, then lifetime gifts can save both income and estate taxes.

Another possibility is to make a gift to a special education savings account. From the tax and estate planning perspective the best of these special accounts may be the 529 plans which are currently available in many states. The newer type of 529 college savings plans allow families to save tax deferred for college until the money is withdrawn, at which point taxes are due at the child's rate. These plans can be a great benefit especially for parents in high tax brackets whose children are unlikely to qualify for financial aid. There are no income limits that prevent parents or grandparents from contributing to these plans. Pennsylvania's Tuition Assistance Program (TAP) has not caught up with the newer kind of 529 plan that is now available in other states, but a bill called the TAP Enhancement Act is making its way through the Legislature. When passed, this legislation will make the newer type 529 plan available in Pennsylvania. For more information on Pennsylvania's TAP plan, call 1-800-440-4000, or use the Internet site: http://www.patap.org

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