Subject: Tax Code - Uniform Gifts to Minors Act (UGMA)
Last-Revised: 8 Mar 2009
Contributed-By: Art Kamlet (artkamlet at aol.com), Aaron Schindler, Mark Eckenwiler, Brian Mork, Rich Carreiro (rlcarr at animato.arlington.ma.us)
The Uniform Gifts to Minors Act (UGMA), superceded by the Uniform Transfers to Minors Act (UTMA) in some states, is simply a way for a minor to own property, such as securities.
The UGMA/UTMA setup is commonly used to give monies to a minor. IRS regulations allows a person to give many thousands of dollars per year to any other person with no tax consequences (please see the FAQ article on Estate and Gift Tax for current numbers). If the recipient is a minor, the UGMA provides a way for the minor to own the assets without involving an attorney to establish a special trust. When giving assets to a minor using a UGMA/UTMA, the donor must appoint a custodian (the trustee).
An UGMA/UTMA is a trust like any other trust except that the terms of the trust are set in the state statute instead of being drawn up in a trust document. Should a trustee fail to comply with the terms of the UGMA/UTMA, this would expose the trustee to the same actions as a trustee who fails to comply with the terms of a special drawn-up
Why is a UGMA useful? The UGMA/UTMA offers a straightforward way for a minor to own securities. In most (all?) states, minors do not have the right to contract. So a minor could not be bound by any broker's account agreement. If a broker took a minor's account, the minor, upon reaching majority, could repudiate any losing trades and make the broker eat them. Thus brokers and fund companies once refused to take minor's accounts. UGMA/UTMA was basically a way of providing a form of ownership that got around this problem, without forcing people to go through the expense of having an attorney draw up a special trust.
To establish a UGMA/UTMA account, go to your friendly neighborhood stockbroker, bank, mutual fund manager, or (close your eyes now: S&L), etc. and say that you wish to open a Uniform Gifts (in some states "Transfers") to Minors Act account.
You register it as:
[ Name of Custodian ] as custodian for [ Name of Minor ] under the Uniform Gifts/Transfers to Minors Act - [ Name of State of Minor's residence ]
You use the minor's social security number as the taxpayer ID for this account. When you fill out the W-9 form for this account, it will show this form. The custodian should certify the W-9 form.
The money now belongs to the minor and the custodian has a legal fiduciary responsibility to handle the money in a prudent manner for the benefit of the minor.
Handling the money "in a prudent manner" means that the custodian can buy common stocks but cannot write naked options. The custodian cannot "invest" the money on the horses, planning to donate the winnings to the minor. And when the minor reaches the age at which the UGMA becomes property of the minor (who is either 18 or 21 depending on the state and not a minor any loger), the minor can claim all of the funds even if that's against the custodian's wishes. Neither the donor nor the custodian can place any conditions on those funds once the minor becomes an adult.
You may be concerned about preventing a minor from blowing the college fund on a Trans Am the moment the minor attains the turnover age and the money is under their control. Legally there is nothing the custodian (or anyone else) can do. Some may sugggest that a UGMA account can be hidden from a minor, but this is a problem for two reasons. First, any minor over age 14 is expected to sign his or her tax return and thus has a good chance to notice the income from the account. Second and more seriously, if the custodian fails to turn over money that is due to the UGMA beneficiary, he or she breaches the statutory trust terms and is liable for the consequences of that failure, just as any other trustee would be, which may include surcharges and other sanctions from a court.
If it is any consolation, some states allow the donor to establish a "turnover" age of 21 (instead of the default 18) by making an express statement to that effect when the account is created. In other states, the turnover age is 21 by default, and an express statement is required to establish a lower turnover age.
The trustee can transfer funds between UGMA/UTMA accounts at will. For example, this might be attractive if a UGMA seems to be underperforming similar type accounts or if it lacks the services of other UGMA accounts such as online access. The custodian is managing the funds on behalf of the minor, and part of management is deciding where to place the funds and with which bank, broker, or other fiduciary. The custodian must be certain to maintain a paper trail showing that every dollar withdrawn from one account was transferred to another account. If the UGMA account is with a broker or mutual fund manager, and a transfer is desired, contact the new broker or manager and they will arrange all the paperwork for a direct transfer.
Given all the warnings above, there is a way to give money to a minor and restrict the minor's access until you feel he or she is ready. The mechanism is not a UGMA, however, but another sort of trust. Contact American Century Investments for information about their GiftTrust fund. The fund is entirely composed of trusts like this. The trust pays its own taxes. Unfortunately, this company may not keep the trust as quiet as you would like. When opening a Gift Trust, confirmation is sent to the donor, but in their words, "Subsequent confirmations are sent to the beneficiary's address." Further, they insist that Form 709 must be filed, it's a future interest and does not qualify for annual exclusion (11,000 in 2003); taxes must be paid now or consume part of lifetime exemption.
A future interest is just what it says: an interest in something that a person does not own until some time in the future. The American Century GiftTrust is an example of that. I believe the terms of the account state that money cannot be taken out of the account for any reason (except death of beneficiary) until the account has been open for at least 10 years. So the beneficiary does not actually truly own the assets until some time in the future. However, in certain situations, the *dis*qualified exemption of a future interest doesn't apply. In other words a Form 709 is *sometimes* not necessary and the lifetime $600K (which is crawling upwards these days) isn't dented. The IRS regs list these disqualifications of the disqualifications (don't you just love tax law?).
In contrast, a minor is considered to own (though he or she does not control) the assets of an UGMA/UTMA account from the second assets are placed into the account -- the assets can be used for his or her benefit immediately. Therefore, gifts to an UGMA/UTMA are gifts of a present interest and do qualify for the annual gift exclusion.
With respect to gifts of a future interest (that are not eligible for the annual exclusion) or for gifts that are eligible but are over the annual-exclusion limit, a donor does not have the choice between paying gift tax and using up some of his or her unified credit. The donor is required to use unified credit first, only paying the gift tax once the unified credit is exhausted. See the article elsewhere in this FAQ on estate and gift taxes for more information.
Note that if the trustee acts in such a way as to give the IRS cause to believe that no true gift was ever actually made, the IRS takes the position that no gift was made and taxes all the income to the parent instead of to the minor. But this is not unique to UGMA/UTMA.
On a related note, some accountants advise that one person should make the gift and that a different person should be the custodian. The reason is that if the donor and custodian are the same person, that person is considered to exercise sufficient control over the assets to warrant inclusion of the UGMA in his/her estate. For more info, see Lober, Louis v. US, 346 US 335 (1953) (53-2 USTC par. 10922); Rev Ruls 57-366, 59-357, 70-348.
All of these are cited in the RIA Federal Tax Coordinator 2d, volume 22A, paragraph R-2619, which says (among other things) "Giving cash, stocks, bonds, notes, etc., to children through a custodian may result in the transferred property being included in the donor's gross estate unless someone other than the donor is named as custodian."
Finally, a word about taxes. Unearned income that accrues to a minor, such as income from a UGMA account, is taxed as follows in tax year 2008. Assuming the child has no other income and is under age 19 (or 24 if a full-time student -- a big change from previous years), the first $900 of unearned income falls into the child's zero bracket. The next $900 is taxed at 15%, and the rest is taxed at the parents' top bracket (marginal rate). The tax on a child's income imposed at the parents' top bracket is the so-called "kiddie tax." If the child is 19 and not a student, or 24 regardless of student status, the parent's tax situation does not come into play at all. All the income is on the child's return and he or she is taxed as an entity unto himself/herself. Always check the Form 1040 instructions for the appropriate number to use for a given tax year. Also note that IRS regulations require all minors 14 or older to sign their own tax returns. Finally, please note that these tax rules are for earned and unearned income for a minor; there is no special tax treatment for UGMA accounts. This means that any sale or exchange of stocks, mutual funds, et.c can result in a capital gain or loss which might have to be reported on the minor's tax return if the gross sales amount combined with other income is high enough.
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