By: Danielle Flory, Esq. and Katherine B. Miller Esq.
Relatives frequently wish to make gifts to minor children to help support the child’s future needs and desires. Donors frequently have two goals for gifts to minors: (1) ensure funds are used for a specific purpose and (2) minimize gift tax. This article will provide an overview of strategies for minimizing gift tax and ensuring that funds are used for the donor’s intended purpose.
Each individual has a $5,450,000 federal gift and estate tax exemption. Some states, including Massachusetts, have a state estate tax that has a much lower exemption amount, so tax planning would be needed for individuals with assets in those states, if their estates exceed the state exemption for gift and/or estate tax. (This amount is periodically adjusted for inflation). An individual making lifetime gifts in excess of $5,450,000 must pay gift tax at the forty-percent rate. Lifetime gifts reduce the exemption amount available to offset estate tax. However, individuals can make “present interest” gifts of $14,000 per year, per recipient without “eating into” the $5,450,000 exemption, using the so-called “annual exclusion.” Spouses can jointly make transfers of $28,000 per year, per recipient, without “eating into” the applicable exemption amount, if the proper “split gift election” is made on a tax return.
A gift tax return must be filed for any year in which the donor makes gifts that exceed the $14,000 annual exclusion amount to any one person, but no tax will be due until the donor exceeds the $5,450,000 unified, lifetime gift and estate tax exemption amount.
From a tax perspective, the best way to provide for a child’s future is to assist with educational and medical expenses. Transfers for educational or medical purposes are not considered taxable gifts, so they will not “eat into” an individual’s $5,450,000 exemption amount or use up the $14,000 annual exclusion amount for each recipient. For lifetime transfers to be excluded from the calculation of taxable gifts, educational expenses need to be paid directly to the institution and must be used for tuition only. Similarly, medical expense payments must be paid directly to the medical care provider. The dollar amount of such gifts per year per donor to an individual recipient is unlimited by the tax laws.
In general, lifetime transfers in excess of the annual exclusion amount (currently $14,000), for purposes other than tuition or medical expenses, are taxable gifts, although, as noted above, no tax is due until the donor exceeds the lifetime federal gift and estate tax exemption (over $5 million).
An individual can also use a Minors Trust or a Uniform Transfers to Minors Account to achieve these goals.
An individual may choose to establish a trust for the minor’s benefit. For the gift in trust to be eligible for the $14,000 annual exclusion (and therefore, not “eat into” the $5,450,000 federal gift and estate tax exemption), the property held in trust and any income therefrom may be used by or for the benefit of the beneficiary before he or she turns 21 and if not fully used, must pass to the beneficiary (or his estate) at 21.
In general, the tax disadvantage of gifts is that the person to whom the property is given has the tax basis of the donor. If the recipient sells the property, the entire appreciation in value from the date when the donor acquired the property, either by purchase or by inheritance, (less the cost of improvements made) is taxable as a capital gain.
Uniform Transfers to Minors Accounts
Alternatively, a donor can choose to transfer property to a custodian for the benefit of the minor under the Uniform Transfers to Minors Act. By using this option, the custodian will take control of the property and will be required to transfer the gifted property back to the minor beneficiary generally when the minor reaches 21 years of age. This type of transfer allows the donor to be eligible for the annual exclusion and helps ensure that the gift is preserved for the minor’s benefit. However, it is important to note that the donor should not be the custodian to avoid inclusion of the transferred property in the donor’s gross estate.
In general, transferring property to a custodian for the benefit of a minor will be less complex than establishing a trust. Additionally, income held in trust is subject to less favorable income tax treatment than income held outside of a trust. However, establishing a trust may give the donor more flexibility and control over the use of gifted property.
DTC’s estate planning attorneys can help you establish a planned giving strategy and evaluate the associated tax consequences including the consequences discussed in this article as well as generation skipping transfer tax for gifts to grandchildren, income tax consequences of a child’s receipt of income producing property, etc.)