Alternatives for Funding Gifts to Minors

• Publication year: 2004
• Author: Linda J. Retz, Esq.

ALTERNATIVES FOR FUNDING GIFTS TO MINORS

Linda J. Retz, Esq.^{* **}

I. INTRODUCTION

In the last two decades, several new and different options have become available to clients wishing to make gifts to young family members without petitioning the court to have a guardian of a minor beneficiary's estate appointed. This article takes a look at the options, from the simplest to the more complex. It concludes with a discussion of the reasons for the proliferation of qualified tuition programs (under section 529 of the Internal Revenue Code) in the last several years.

No one vehicle is ideal for every client. The appropriateness of a particular vehicle will depend on many factors, among them, the degree of control the client wishes to exert over gifted assets, tax considerations, the costs of using a particular vehicle, investment options, the type of asset being given and the purposes for which distributions can be made to the beneficiary. Newer vehicles are not necessarily better than older ones. The analysis of what suits the client best must be done on a case by case basis. This article restricts its discussion to California law.

II. UNIFORM TRANSFERS TO MINORS ACT (FORMERLY THE UNIFORM GIFTS TO MINORS ACT)

A. Age for Distribution to Beneficiary

The California Uniform Transfers to Minors Act, operative in July of 1991 ("UTMA"),¹ has several features that its predecessor, the Uniform Gifts to Minors Act, did not. For example, rather than requiring that assets be distributed to the beneficiary at age eighteen (the age of majority²), the newer Act allows distribution to be postponed up to age twenty-one in the case of lifetime gifts. To specify an age for distribution which is older than eighteen, the gift has to be made to a named individual or trust company "as custodian for [name of minor] until age [age for delivery of property to minor] under the California Uniform Transfers to Minors Act."³ If a minor dies before becoming entitled to receive the custodial assets, the assets must be distributed to the minor's estate.⁴

B. Assets That May be Gifted

Any type of property may be the subject of an UTMA gift.⁵ However, in this author's experience, this vehicle is not typically used when gifts will be made of real estate or interests in real estate.

C. Custodian

The UTMA custodian may be an adult individual or a trust company.⁶ There may be only one custodian at a time.⁷

D. Beneficiary

An UTMA transfer may have only one beneficiary.⁸ The beneficiary may be a minor (i.e., someone under 18 years of age) or, as to assets that will be held until a later age under Probate Code § 3920, the beneficiary may be someone under that age.⁹ Distributions may be made for the beneficiary's use and benefit in amounts the custodian considers advisable. These distributions may be made without court order, without regard to anyone's ability or duty to support the beneficiary and without regard to the beneficiary's own income or property.¹⁰

E. Investments and Records

The custodian must manage UTMA assets in keeping with the prudent person standard. However, the custodian will not be liable for retaining custodial property received from a transferor that performs poorly.¹¹ Custodial assets must be clearly identified as such and maintained separately and distinctly from other assets.¹² Records of all transactions must be kept, specifically including information needed for the preparation of the beneficiary's tax returns. These records must be made available for inspection by the beneficiary, if he or she has attained fourteen years of age, or by the beneficiary's parent or legal representative.¹³

F. Tax Considerations

1. Gift Taxes. UTMA gifts held until the beneficiary reaches age 21 or a younger age qualify for the annual per donee gift tax exclusion ($11,000 in the year 2004).¹⁴

2. Estate Taxes. UTMA gifts are completed gifts, for estate tax purposes, with two exceptions. If the transferor is the custodian (the first exception), his or her broad discretion to make distributions for the beneficiary's benefit will cause the UTMA assets gifted by the transferor to be subject to estate tax under I.R.C. § 2038.¹⁵ It may be possible for a donor to serve as custodian without these adverse estate tax consequences if the donor files a declaration with the court, under California Probate Code § 3914(d), by which an election is made to subject the custodianship to court supervision; however, no guarantee is offered in this regard. If the election is filed with the court, no part of the custodial property may be paid out to the UTMA beneficiary or used for his or her benefit without a court order and a showing to the court that the expenditure is necessary for the beneficiary's support, maintenance or education.

The second exception comes into play when anyone with a legal obligation to support the beneficiary is serving as custodian. California Probate Code § 3914(a) states that distributions for the beneficiary's benefit may be made without regard to another person's legal obligation to support the UTMA beneficiary. Under Treas. Reg. § 20.2041-1(c)(1), "[a] power of appointment exercisable for the purpose of discharging a legal obligation of the decedent . . . is considered a power of appointment exercisable in

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favor of the decedent or his creditors," i.e., a general power of appointment. Therefore, if a custodian other than the transferor has a legal obligation to support the UTMA beneficiary and dies while the legal obligation exists (e.g., during the beneficiary's minority), the UTMA assets will likely be subject to estate taxes in the custodian's estate.¹⁶ If the court has to be petitioned before UTMA assets can be used to discharge the legal obligation, a different result should obtain.¹⁷ However, the provisions of Probate Code § 3914(d) (permitting a custodian to subject the custodianship to court supervision) appear to apply only to transferors who are serving as custodians.

3. Generation-Skipping Transfer Taxes. UTMA gifts to persons two or more generations younger than the transferor are subject to generation-skipping transfer tax. However, they do qualify for the annual GST per donee exclusion ($11,000 in the year 2004) because (a) the UTMA beneficiary is the exclusive beneficiary of the account while he or she is living and (b) upon the beneficiary's death before the distribution of all UTMA assets to him or her, the assets will be distributed to the beneficiary's estate. Thus, both of the requirements under I.R.C. § 2642(c)(2) (for qualification for the GST annual exclusion) are met.

GST tax will be imposed to the extent that gifts to someone two or more generations younger than the transferor: (a) exceed the annual exclusion, and (b) the transferor's GST exemption ($1,500,000 in the year 2004) either has been used in full or was not effectively allocated to the gifts (automatically or by an allocation made on a gift tax return).

4. Income Taxes. While a minor beneficiary is under 14 years of age, net unearned income on UTMA assets will be taxed by reference to the tax bracket of the beneficiary's parents. Commencing when the minor attains age 14, UTMA income is taxed to the beneficiary on his or her own income tax return, with one exception. To the extent that the income is used to discharge the legal obligation of the beneficiary's parents to support the beneficiary, it will be taxed to the parents.¹⁸

G. Non-Tax Planning Considerations

An UTMA custodian has investment responsibilities similar to those of a trustee in that he or she will be held to the prudent person standard of investing and can be made to render an accounting on request by the beneficiary, the transferor, certain representatives of either of them or a successor custodian.¹⁹ The custodian's broad discretion to use assets for a beneficiary's benefit before he or she reaches the age of majority, coupled with the transferor's ability to postpone distribution of the custodial assets to the beneficiary up to age 21, makes the Uniform Transfers to Minors Act an attractive vehicle for the making of gifts to a beneficiary under the age of 21 years. However, at age 21, the beneficiary still may not be mature enough to use the assets wisely.

H. Uses

Much of the appeal of UTMA gifts lies in the statute's familiarity. It has stood the test of time and is readily understood by clients and financial institutions alike. As long as the client is willing to have the gifted assets pass to the beneficiary at age 21 or a younger age and give the custodian control of the assets until then, UTMA is still a good vehicle for implementing gifts to young family members if the gifts are not made strictly for education. Qualified tuition programs and education savings plans are the preferred vehicles for implementing gifts for education because they offer greater tax benefits and more control.

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Under California Probate Code §§ 3400-3402, if following the making of a gift of money or other property to a minor, the total estate of the minor (excluding property held under the Uniform Transfers to Minors Act or pursuant to court order) will be $5,000 or less, the gift may be made to the minor's custodial parent, to be held "in trust" for the minor until he or she reaches the age of majority. However, the parent must provide a written assurance, under oath, that the value of the minor's total estate (including money and other property) does not exceed $5,000. Query whether gifts made in this fashion will qualify for the annual per donee gift tax exclusion ($11,000 in the year 2004).²⁰

III. GIFTS MADE FOR THE TUITION OR MEDICAL CARE OFANOTHER

A. Gift Recipient

I. R.C. § 2503(e) applies to transfers made after December 31, 1981. It deals specifically with amounts paid, on behalf of another, for the individual's tuition or medical care. If payments for tuition are made to an educational organization described in I.R.C. § 170(b)(1)(A)(ii) or payments for medical care are made to the provider of that care, as defined in...