It’s my annual “Taxes from A to Z” series! For the series, I’ll focus on terms that you might see on your tax forms and statements but not necessarily in the headlines. If you’re wondering whether you can claim wardrobe expenses or whether to deduct a capital loss, this is one series you won’t want to miss.
U is for UTMA/UGMA Accounts.
My kids will be the first to tell you that in most states, minors cannot own property outright (they’re counting down the days until they can own stuff). That’s why you typically see trusts created to hold assets for minor children: depending on the terms of the trust, the child can receive the benefit of the trust assets until he or she is old enough to own the property.
One of the most simple ways to transfer property to minor children – in trust – without actually creating a trust document is to take advantage of existing laws to create a Uniform Gift to Minors Act (UGMA) or a Uniform Transfer to Minors Act (UTMA) account. You can open an UGMA account right at the bank: no lawyers to pay and no extra papers to sign. It used to be the case that an UGMA account typically held cash, securities, bonds and other assets easily converted to cash while an UTMA held other types of property like real estate; the terms are now generally used interchangeably, depending on state law.
With an UTMA or an UGMA, a donor (often a parent or grandparent) transfers assets to an account for the minor child. The donor appoints a person to watch over the funds on behalf of the minor child, sometimes called a custodian (or trustee). The custodian is charged with holding the assets on behalf of the minor child until he or she reaches the age of majority.
And this is where things get tricky: even though the child can’t own the property outright, the child is considered the owner of the account for federal income tax purposes. The account will be opened in the name of the child using the child’s tax ID number. Any income from the account will be attributed to the child and subject to the kiddie tax rules.
The kiddie tax rules dictate that if the child’s only income is unearned, which generally means income from dividends and interest, and the child was under age 19 at the end of 2015 or was a full-time student under age 24 at the end of 2015, the child’s parent can elect to include the child’s income on the parent’s return: the child doesn’t have to file a return.
With respect to the rate of tax payable, for 2015, the first $1,050 is considered tax-free and the next $1,050 is taxed at the child’s rate. Unearned income over $2,100 is taxed at the child’s parents’ tax rate. Income which is taxed at the child’s parents’ tax rate does not necessarily mean that the income has to be included on the parents’ tax return; the child can opt to file a separate return (and in fact, that can sometimes be preferable for all kinds of reasons, including the dreaded AMT).
One quick word of warning: Since the minor child is considered the owner of the assets in a custodial account, it may affect any potential financial aid for purposes of paying for college. Be sure to ask if you’re not sure of the potential impact.