If you wish to maximize wealth transferred to a minor child or grandchild without having to file a gift tax return, you have several choices and combinations of choices, each yielding different tax implications and levels of control. This article explores several of those choices.
Because this article frequently references “annual exclusion gifts,” here is a short explanation. The IRS only needs to know about gifts if they exceed the annual exclusion amount which is currently $15,000 per year per person. Said another way, this is the amount that can be “excluded” from the annual gift reporting requirement. Under current law, you may give this amount to an unlimited number of individuals. If you are married, your spouse may also give that same amount. Thus, a fortunate child might receive $30,000 from her parents, $30,000 from her grandparents, $30,000 from her great grandparents, and $30,000 from her neighbors each year, and nobody is required to report a gift. Furthermore, a set of grandparents blessed with fifteen grandchildren may give $450,000 per year without needing to file a gift tax return. If all fifteen grandchildren are married, including in-laws translates to $900,000 in possible annual exclusion gifts. Amounts given in excess of these amounts would need to reported on a gift tax return and would utilize a portion of your lifetime gift and estate tax exemption.
These annual exclusion gifts may be made outright or in more protective ways utilizing trusts. In addition, there are means of benefitting a minor without utilizing the annual exclusion or your gift tax exemption. Here are some of your choices for transferring wealth to a minor child without reporting a gift to the IRS and without utilizing any of your gift and estate exemption amount.
1. Pay directly for certain expenses without it being a gift and without utilizing the annual exclusion: The two methods below can result in significant amounts transferred over time and provide real support for the child without giving them access to cash:
Note: If you tire of chasing children and grandchildren around for bills and statements, consider establishing a bank account in your name but with the child (or the parent) as a signor. If you choose this route, you still need to be sure the account is only used to directly pay tuition and medical expenses. You, the child, or the parent should keep records of the payments along with your tax information should you ever need to produce records for an IRS audit.
2. Basic gifts to a minor’s custodial (UTMA) account utilizing the annual exclusion gifts: Every child needs a basic savings account at the bank and eventually an investment account. Where else will they put all the cash from their lemonade stand and lawn mowing business?
3. Mitigating the minor’s account “Knucklehead Risk” with the use of a trust to receive, hold, and manage your annual exclusion gifts: Qualifying for the annual exclusion while using a trust requires the beneficiary child have a present interest in the gifted property or else the trust must comply with an exception to that rule provided by Section 2503(c) of the Internal Revenue Code.
4. 529 College Savings Plans: As you can see from this article written by Mary Lou Daly, 529 plans offer superior income tax advantages over normal taxable accounts and especially over trusts, which are subject to compressed tax rates. Further, based on the advantageous flexibility and control attributes, we are convinced that the committee that designed these plans never met with any IRS staffers.
5. Implementing multiple strategies to maximize wealth transfer or to serve different purposes:
All of the methods detailed herein have assumed you wish to transfer wealth without being required to file a gift tax return. There is certainly no rule that says you can’t implement multiple wealth transfer strategies that do require a gift tax return or the use of your gift and estate tax exemption. Further, each of the strategies described needs a deeper conversation; the introductions above are not meant to be comprehensive or taken as “advice” outside of a broader conversation about your plans and objectives. Let us know if you’d like to review whether you are taking best advantage of the opportunities available to you as donor.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.