Are you thinking about opening a custodial account for a child or grandchild? These unique accounts are set up for a variety of reason, some legitimate and some maybe not so legitimate. It all depends on the intentions of the person making the donation or gift to a minor who is need of a custodial account. Many of these accounts are established for schooling and college because the child has inherited a substantial sum of money, or in the days of the past because the parents or grandparents were looking for tax advantages. Before you establish one of these unique accounts for a minor there are some things that you need to be made aware of and think about prior to establishing the custodial account.
The first and maybe one of the most important things to know about the establishment of a custodial account is the money is no longer yours, and they irrevocably belong to the minor who the account was established. Now most parents or grandparents are the ones who create these accounts and they normally name themselves the custodian or manager of the account. While these people are the custodians of the account and determine what the money will be spent on there is a rule that cannot be broken in this complicated process. The money has to be spent on and for the benefit of the child who the account was established. The money cannot be used to buy a car for the custodian as an example and the funds also cannot be given to another child after the establishment of the account. The money is to be used for the minor in which the account was established and no one else although it can be a fine line when it comes to that child and other family members.
Be prepared to hand over control of the custodial account to your child or grandchild at a relatively young age, 18 or 21 depending on your state. All minor custodial accounts as established under one of the two methods, the Uniform Gift to Minors Acts (UGMA) or Uniform Transfer to Minors Act (UTMA). At whatever age your child ceases to be a minor they gain control of the account and whatever is in it. When children are young, we never have any idea what they will be like as a teenager or young adult. We all have heard the stories of children who are “trust” babies and many of these stories stem from one of these two acts.
And the final area of concern deals with various tax issues. As in any case that involves taxes or complex financial issues I urge you to contact a professional that can best help you in your situation. First depending on how much the custodial account makes in a tax year you may be required to file a tax return for the account and child. This provision begins when the account generates more than $1,000 in income. This tax provision also applies to state taxes so check with your state on how they deal with custodial accounts and their taxation. The exception to this is if all the income from the custodial account is from interest, dividends, and mutual fund capital gains you may be able to add that income to your tax return. For more information, please seek the advice of a professional in your areas and for further information, please look for IRS Form 8814, Parent’s election to Report Child’s Interest and Dividends.
Be on the lookout for the possibilities of the Kiddie Tax. In previous years, money could be given to a child in a custodial account as the gains were taxed at the child’s tax rate and not as it is not the parent’s tax rate. That means what could have been only a tax of 0; 10; or 15 percent now may be as high as 39.6% depending on the parent’s tax bracket. This tax rue will begin when the income from the custodial account is in excess of $2,000. For more information on this particular tax, please seek the advice of a professional and look at IRS Form 8615.
And the final tax we will look at that could affect a custodial account is the gift tax. Now this is a tax that the person who makes the gift reports on their tax return and very rarely are any real taxes paid on gifts. People are allowed to gift up to $14,000 a year to an individual and if you are married that doubles to $28,000. In the event, you exceed that amount there is always your lifetime gifting amount of $5.25 million over a lifetime. If more than the annual amount is gifted IRS Form 709 must be filled. And be on the lookout for generational skipping taxes if the person is more than 34 years younger than you are at the time of the gift.
For more information on custodial accounts feel free to contact me or seek the advice of a professional in your local area as these can be complicated accounts, and you need to be properly advised in their handling.
