Gifts to Minors
The annual federal gift tax exclusion allows an individual to gift up to $17,000 (or $34,000 if spouses elect to split gifts) in 2023 to as many people as he or she wishes, without those gifts counting against the $12.92 million lifetime gift tax exemption. As a result, depending upon the size of their families, parents and grandparents can make annual gifts to their children and grandchildren that may easily exceed $100,000 per year, without incurring a gift tax or reducing the lifetime gift tax exemption amount. Over time, annual gifting can effectively reduce the donor's gross estate by removing the value of the gifts, as well as all the future appreciation associated with those gifts.
When making these annual gifts, the donor must decide whether or not to make an outright gift. However, when gifting to a minor, an outright gift of any substantial size is almost never advisable. Accordingly, the donor should consider alternative methods that offer continued control in order to preserve the gift and allow it to appreciate for the benefit of the minor.
The 2503(c) trust and the Crummey trust are two of the most commonly utilized methods for making annual exclusion gifts to minors.
A 2503(c) trust, or minor's trust, is a trust established to hold gifts for one child until he or she attains age 21. A gift to this type of trust qualifies for the annual federal gift tax exclusion. Principal and income in the trust can be distributed to the child or used for the child’s benefit, in the discretion of the Trustee. Unused or undistributed principal and income can be accumulated in the trust until the child reaches age 21. The trust can be authorized to invest in virtually any prudent investment.
There is no need for “Crummey” withdrawal notices (as required for insurance trusts and Crummey trusts) and, to the extent the trust is maintained for college costs only, virtually all the trust assets may be gone by the time the beneficiary attains age 21. Upon the child reaching age 21, the trust must terminate and the remaining assets must be distributed outright to the beneficiary. However, if the trust is intended to hold more than college funds and the Trustee would like the assets to remain in trust after the child’s 21st birthday, the beneficiary may be given a short period of time after reaching age 21 (typically 30 or 60 days), during which he or she has the unrestricted right to withdraw the remaining trust funds. If the funds are not withdrawn, the assets can be continued in trust.
Prior to the beneficiary’s turning age 21, income retained by the trust is taxed to the trust. Because the trust is a separate taxpayer, separate income tax returns for the trust must be filed each year. Any income distributed to the beneficiary will be taxed to the beneficiary, subject to the kiddie tax rules. After the beneficiary turns 21, the beneficiary will be treated as the owner of the trust and will be taxed on all trust income, whether it is distributed or accumulated.
A Crummey trust allows a parent, grandparent or other donor to make tax-free gifts to a child’s (or children's) trust and use their annual federal gift tax exclusion. A Crummey trust may allow the Trustee to make discretionary distributions or, instead, may limit distributions to an ascertainable standard, such as the beneficiary’s education, health, maintenance or support. Investments can be in whatever the trust document provides.
Immediately following a gift to such a trust, notice of the gift must be given to the beneficiary (or the non-donor parent of a minor beneficiary) and the beneficiary is given a period of time during which the gift may be withdrawn from the trust. When the withdrawal period ends, the gifted amount irrevocably becomes the property of the trust. The withdrawal right creates a present interest in the gifted amount so that the gift qualifies for the annual gift tax exclusion.
Unlike the 2503(c) trust, there is no mandatory distribution of trust principal at age 21. However, the administrative burdens of documenting gifts and withdrawal notices can sometimes serve as a deterrent to establishing this type of trust. A parent or Trustee may inevitably face the dilemma of dealing with a beneficiary who inquires about distribution of the amount over which he or she holds a withdrawal power each year when the Crummey notice is given.
It is important to note that, although income distributions are not required to be made, the income of the trust can be taxed to the beneficiary. The lapse of the Crummey withdrawal right is generally believed to cause the beneficiary to become a grantor of the trust and, accordingly, the income will be taxed to him or her. This may be a desirable result after the child attains age 19 and, presumably, is in a low income tax bracket.