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The Minor's Trust Legal Tax Angles: How to Save Taxes Without Going to Jail
Normally, a gift in trust is not a gift of a present interest and is not eligible for the annual gift tax exclusion . It doesn’t become a completed gift until the property is distributed to the child. To overcome that problem, the Congress authorized a special trust for minors that permits the use of the $11,000 per donor annual gift tax exclusion. Internal Revenue Code 2503(b) and 2503(c) expressly permit gifts in trust for the benefit of a minor - which also qualify for the annual gift tax exclusion. With the 2503(b) trust, the trust is required to make annual (or more frequent) distributions to the child but the assets of the trust do not have to be distributed when the child reaches age 21. With a 2503(c) trust, the assets must be distributed when the child is age 21. The trust may either distribute income to the minor (or on behalf of the minor) each year or it may accumulate income and pay taxes on the accumulated income at the trust tax rates. It's usually better to distribute the income and pay the tax at the child's tax rate. The 2503(c) trust is best suited for situations where the donor (usually the parents) want a more flexible form of ownership for certain assets than is available with the UGMA. In addition, the trustee can make distributions on behalf of the minor rather than having to make the distribution to the minor directly. Because the income earned by the trust assets must either be distributed to the child (and taxed to the child) or taxed as income of the trust, it’s usually better to use this type of trust after a child reaches the age of 14. Prior to that age, any income of the child in excess of $1,500 a year is taxed at the highest rate of the parents. However, the income tax rates for a trust are very steep and there are hardly ever any good reasons to let the trust accumulate income on which the trust pays the income tax. Any income earned by the assets in the trust are subject to income tax by the beneficiary or by the trust. If the beneficiary is under the age of 14, the first $750 a year of unearned income is tax free. The next $750 of unearned income is subject to tax at the 10% rate. Any excess investment income is taxed at the highest rate of the child’s parents. If appreciated assets are gifted directly to a child and are sold by the child, then the taxable gain will be shifted to the child. However, if the trust needs to sell any appreciated assets, it will incur a capital gain. In order to have the capital gain taxed to the child, the trust will need to make a distribution of all its ordinary income for the year as well as the capital gain. Otherwise, the capital gains will be taxed to the trust, at the higher trust tax rates. Transfers to the 2503(b) and 2503(c) trust are eligible for the $11,000 annual gift tax exemption. Future income or gains from the assets transferred to the trust will be taxed to the children who are the beneficiaries of the trust, when the income is distributed to them. If the trust accumulates any income it will be taxed on that income at the trust tax rates. If the donor survives until the child is of legal age or if the donor is not a trustee, then the assets transferred to the trust, and any income earned by the trust, will be excluded from the donor’s estate. The use of a 2503(b) or 2503(c) minor’s trust will require the drafting of a trust agreement and the transfer of any assets to the trustee. A trustee other than the donor will need to be appointed. To avoid adverse tax results, the donor should not be a trustee or successor trustee of the trust. If the donor is a trustee or can become a trustee, and if the donor dies while in the capacity of a trustee, then the trust assets may be included in the estate of the donor. If the income of the trust is used for the support obligations of the parent, or if it’s used to pay premiums on a life insurance policy where the donor or the donor’s spouse are the insured, the income will be subject to tax by the donor. A trust form 1041 will need to filed each year. If transfers to the trust are in excess of the $11,000 annual gift tax exclusion, a gift tax return is required on form 709 or 709-A. Vern Jacobs Copyright, 2003 |
Books and Services by Vern Jacobs
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