Case study: making gifts to minors.

• Author: Ellentuck, Albert B.

ONE OF THE LEAST-COMPLICATED LONG-term methods of funding education for children is a gifting plan under the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). Generally, UGMA or UTMA funds can be used to pay a child's college education expenses, provided such costs are not part of the parental obligation of support of either parent (under state law or other agreement (e.g., divorce decree)). Due to difficulties associated with guardianships, the UGMA was developed in 1956 and was adopted in some form in all 50 states to allow parents, grandparents, or others to transfer assets to a custodian for the benefit of a minor child.

Unlike a trust, a custodianship is not a separate legal entity or taxpayer. The custodial property is fully vested in the minor, so any income is taxed to the minor, regardless of whether it is distributed. Unlike a guardian, the custodian is not accountable to a court and has broad powers over investments. Commonly, the custodian (who may be a parent) simply establishes a UGMA account at a financial institution and transfers funds to it. The income is reported under the child's Social Security number on his or her tax return. No separate legal forms or trust documents are required. The custodian takes title and holds property for the minor's benefit and must distribute the assets to the minor upon his or her reaching the age of majority (18-21, as determined under state law). Many potential donors consider this requirement the biggest drawback to UGMA gifts.

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The UGMA, as originally enacted, did not allow a custodial account to hold real estate and various other investments. A revised act, the UTMA, has been adopted in many states to allow a custodial account to hold real estate, personal property, limited partnership units, and other investments. In addition, UTMA accounts generally terminate at age 21 (as opposed to age 18 in the case of many UGMA gifts), although some states allow UTMA custodianships to extend until age 25. This longer duration is an attractive feature of UTMA gifts when compared with the more limited duration of UGMA gifts. To ensure that clients get the benefit of the longer duration, practitioners should advise them not to commingle current UTMA gifts into existing UGMA accounts that terminate at age 18. A gift under the UGMA/UTMA is diagrammed in the exhibit below.

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For income tax purposes, income earned on UGMA/UTMA...