Many of our clients like to make annual gifts to their children and grandchildren. Such gifts may be subject to a gift tax (to be paid by the donor), however, federal law offers certain exceptions that can help gift givers enjoy a bit of tax relief while still generously sharing their wealth with the next generations.
One such provision is an annual gift tax exclusion that applies to gifts made outright (not in trust) that are up to $15,000 for each person receiving a gift. Such gifts to children, grandchildren or even friends can be made tax-free and can reduce one's taxable estate because they are basically ignored for estate and gift tax purposes.
Of course, giving sizable cash gifts directly to a minor child or grandchild may be problematic, so that it is common for the gift to be donated to a custodial account for minors under a state's Uniform Transfers to Minors Act (UTMA), whereby a custodian holds the funds until the minor reaches the age of majority.
However, a donor needs to be careful in selecting the custodian for the minor's custodial account. For example, if a gift is donated to a custodial account for minors under a state's UTMA and the donor names herself or himself as custodian, the account's value might potentially be included in the donor's estate for estate tax purposes. This could happen if the donor were to die while the beneficiary was still under the age designated for the custodianship. The reason for this catch: the donor technically would not have given up the requisite control of the "enjoyment" of that gift, which the law considers as a continued type of ownership over the gifts made.
A simple solution to this issue may be to name another family member (not the child's parent as there may be tax reasons for not naming a parent) to act as custodian. Another possible solution is to make the gift to a 529 College Savings Plan, because the donor's control over 529 plans is ignored for estate tax purposes.
We have found that many parents are alarmed when their child approaches the age of the termination of the UTMA account (usually 18 or 21). By that time, the series of relatively modest annual gifts of $10,000 to $15,000 might have grown to $250,000 or more. Few parents want their 18-year-old son or daughter withdrawing the account's funds and treating friends to weekends in Reykjavík. In any case, state law dictates that UTMA accounts must be distributed to the child by age 21 at the latest.
There is a way to resolve such a problem. If a trust were created to hold those annual gifts instead of a custodial account, there are methods that can be employed to convert a gift that would not otherwise qualify as an annual exclusion gift to an annual exclusion gift. When the trust is created the grantor (parent or grandparent) can designate an age, beyond 21, when the child will be able to receive the trust account. Some grantors even choose to have the funds held for the lifetime of the child.
It takes great discipline – and a generous spirit – to provide annual gifts to loved ones that can, over many years, help to secure their futures. The right strategies for gift giving, marked by a keen understanding of the tax code, can help to ensure that more dollars flow to these beneficiaries and that fewer make it into federal and state tax coffers.
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