Giving Significant Money to Your Kids
In this article, you will find:
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For example, if you give your teenager stock you've owned for a while that has appreciated, your teenager may pay only half the tax you'd have paid on the sale of that stock. You'd pay 20 percent capital gains tax; she'd pay only 10 percent (if she's in the 15 percent tax bracket on his other income).
If you set up a trust for your child and funds in the trust are used to satisfy your parental obligation of support, then you—not your child—are taxed on the income from the trust, which defeats the income-shifting purpose of the trust.
- There's little or no gift tax cost to you or your child for making a gift. Each year you can give up to $10,000 to your child, and your spouse can also give $10,000 (for a total of $20,000). You can give each of your children up to this amount each year. This is called the annual gift tax exclusion (and may be adjusted for inflation in the future). For example, if you're a single parent with three children, you can give away up to $30,000 each year if you give each child $10,000. Over five years, this can total up to $150,000 in transfers that are completely tax-free. Gifts over the annual exclusion may also be tax-free because of the exemption amount mentioned earlier. However, to the extent the exemption amount is used for gifts, it's not available for a person's estate.
Watch Your Step
You can't deduct gifts you make to your kids or others. While they may be free from gift tax if they're under a certain amount, you don't get to claim a deduction for them on your income taxes.
You can benefit your child even more without triggering any gift tax. You'll allowed to make payments of medical and educational expenses in any amount as long as they're made directly to the service provider (such as the doctor or the school). And, if you put money into a qualified state tuition program for their college education, you can treat the gift as if it were made over five years. So, if you put in $100,000 (the limit allowed in some states), you can treat it as though $20,000 contributions were made each year, which allows a couple to avoid all gift tax.
For more information about the kiddie tax and other tax matters, see IRS Publication 929, Tax Rules for Children and Dependents, which can be downloaded from the IRS Web site. Or you can have the publication sent to you by calling 800-TAX-FORMS.
Piggybank on It
To determine whether UGMA or UTMA applies in your state, ask a local attorney or call the Commissioner on Uniform State Laws at 312-915-0195.
Watch Your Step
Trusts are a very complicated subject, so don't try to do this yourself. Get the help of an attorney who's experienced in trust matters. The size of the lawyer's bill for this help will depend in part on the complexity of the trust you want.
How to Make Gifts to Your Child
Let's say you decide you want to give your child expensive gifts for the reasons mentioned previously. Expensive here doesn't just mean a color TV; it means something more like a stock portfolio. How should you do it? You don't want to hand over $5,000 in large bills to a 7-year-old—or, for that matter, even a 17-year-old.
Financial Building Blocks
UTMA is now the law in 46 states and the District of Columbia. The differences between UGMA and UTMA generally are that UTMA doesn't have any limits on the types of property that can be held in custodianship; UGMA is usually limited to bank and brokerage accounts and securities. Also, custodianships under UTMA don't end until the child is 21; under UGMA, they can end at 18.
Generally, gifts to a child under 18 of this magnitude should be given in one of two ways:
- Custodianship. State law allows gifts to be made to minors under the Uniform Gifts to Minors Act (called UGMA, for short) or the Uniform Transfers to Minors Act (called UTMA, for short). The Act you use depends upon which one applies in your state.
Title to bank and brokerage accounts, stock certificates, and other property is held in the name of an adult as custodian for the child. The property is listed under the child's Social Security number, and the child (not the custodian) pays tax on the income from the property. Custodianships are easy to set up and don't require the services of a lawyer. Still, your child has an absolute right to the money when the custodianship ends at age 18 or 21. If he wants to blow it on a Mustang instead of using it for college as you'd hoped, there's nothing you can legally do about it.
- Trust. When assets are very significant, or when you don't think that your child should have control of them at 21, you may want to use a trust to hold property you give to your child. Trusts are discussed in Setting Up a Trust Fund.
In deciding whether to use a custodianship or a trust, consider several factors:
- Size of the gift. The bigger the gift, the more you should look into trusts. It's a way to put lots of assets in one place and manage them together, and this can make for better investment decisions.
- Age of your child. Even if gifts are modest, you may expect that the funds will appreciate over the years and can grow substantially if you start when your child is young. Your child can wind up with a fund that you'd have wanted to place in a trust from the beginning.
- Personal wishes. You may want to tailor an arrangement to limit a child's access to funds. For example, you might not want him to get all the money at 21. A trust can limit distributions to age 25, 30, 35, or whenever and to whatever extent you want. To do this, you'll need to use a trust.