There are many reasons why you might want to gift assets to minor children (children under the age of 21). For example, you may want to help the children build a college fund, or increase the children's future financial security. Or, you may have tax reasons for making gifts to minor children, such as removing highly-appreciating assets from your gross estate to minimize estate taxes. However, gifting assets directly to minor children can be problematic because:
- Minor children are generally too emotionally immature and financially inexperienced to manage large sums of money or other assets on their own
- Most people (and institutions such as brokerage firms or banks) are reluctant to deal directly with minor children because they can renounce or make void many legal transactions involving their property
While a custodial account (discussed further below) could be used to solve these problems, a trust for minors (i.e., an irrevocable trust specifically set up for the benefit of someone under the age of 21) can also be used and has other benefits as well.
Assets in a trust can be held until the child is older and wiser, preventing the child from spending foolishly. And, a trustee can manage and control the trust assets on behalf of the minor beneficiary.
Further, however, trusts can be individually designed to address your particular circumstances. For example, a trust can provide that a fixed amount of principal and income be distributed to the minor beneficiaries at specific intervals or a trust can provide that such matters be in the complete discretion of the trustee. But, although trusts provide flexibility, they also require ongoing administration, and unless structured properly, gifts in trust do not qualify for the annual gift tax exclusion.
The federal annual gift tax exclusion problem
Most donors want their gifts to qualify for the federal annual gift tax exclusion, which allows you to gift tax-free $16,000 (in 2022) each year to an unlimited number of donees. Only gifts of "present interests" qualify for the exclusion. A present interest gift allows the donee to immediately use, possess, or enjoy the gifted property. Gifts to an irrevocable trust generally do not qualify for the exclusion because the donee is unable to use, possess, or enjoy the gifted property until sometime in the future. But, gifts in trusts for minor beneficiaries will be treated as present interest gifts that qualify for the exclusion as long as the trust is structured properly.
2503(c) trust, 2503(b) trust, and Crummey trust
There are three types of trusts that are commonly used for the benefit of minors. Two of them are named after the Internal Revenue Code sections that authorize them: the Section 2503(c) trust and the Section 2503(b) trust. The Section 2503(c) trust may be created only for minors, while the Section 2503(b) trust can be used with both minor beneficiaries and older ones. The Crummey trust (named after the case of a now-famous taxpayer) may be useful in a variety of situations for both minor beneficiaries and older ones.
Gifts can be made to any of these three types of trusts that qualify in whole or in part for the annual gift tax exclusion. This is the significant, common feature among the three. The three types of trusts for minors differ with respect to the nature of the interest the minor beneficiary has.
With a 2503(c) trust, the principal in the trust must be paid out to the minor beneficiary when he or she reaches the age of 21. Until that time, there is no requirement that trust income be paid to the minor beneficiary.
With a 2503(b) trust, by contrast, all income must be paid out to the minor beneficiary each year, but there is no requirement as to when or if (or to whom) the principal must be paid out.
The defining feature of a Crummey trust is really just a single provision in the trust document that gives the minor beneficiary at least a 30-day window of opportunity to immediately withdraw any gifts made to the trust.
Alternative to trusts: Uniform Gifts to Minors Act and Uniform Transfers to Minors Act
For smaller gifts to minor children, when the costs associated with a trusts is not justified, many people take advantage of a custodial account that can be created under one of two similar laws found in every state: the Uniform Gifts to Minors Act (UGMA), or the much more common Uniform Transfers to Minors Act (UTMA). Under either one of these two acts, you make a gift to a custodial account for the benefit of a minor child. The custodian, who makes the decisions regarding account investments and distributions, can be any adult. These custodial accounts are much simpler and cheaper to use than a trust. You won't need to hire an attorney to set one up, unlike a trust, and gifts to a custodial account will qualify for the annual gift tax exclusion. However, there are also many limitations on these accounts.
This article was prepared by Broadridge.
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