Transferring Assets to Your Minor Children
In many cases, it makes sense for a parent/taxpayer to start transferring his wealth to his children well before the end of his own life expectancy and even before his children have reached their majority. There are two primary advantages to making such transfers. The first advantage is that of estate tax savings. When assets are transferred by the taxpayer and he retains no control over their ultimate disposition, they will not be included in the taxpayer's estate for federal estate tax purposes upon his death. Also, any appreciation in the value of the assets following their transfer would not be included in the taxpayer's estate.
The second advantage to making transfers of assets to the next generation at a relatively early point in the taxpayer's life is the nontax advantage of securing the inheritance of the taxpayer's descendants and safeguarding resources that can be used for their present needs, such as education. The taxpayer can retain control as to the amounts to be distributed and as to the purposes for which the distributions can be used.
One means of transferring property to a minor without giving the minor immediate control of it is to establish a custodianship for the minor. Such a transfer is an outright gift that resembles a trust because it is held and administered by a third person (the "custodian") who has the power to expend the custodial property for the use and benefit of the minor. If the donor is himself the custodian, however, there is a possibility that the full value of the transferred property would be included in the donor's estate for federal estate tax purposes.
An alternative means of transferring property to a minor is through the use of a trust for the minor's benefit. In order to secure tax savings, the trust has to satisfy the following Internal Revenue Service requirements. First, the transfer has to be for the benefit of a minor, meaning an individual who has not attained age 21 as of the date of the transfer. The trust must provide that trust income and principal may be used for the donee's benefit prior to his reaching age 21 and any income and principal not expended for the donee's benefit during his minority must pass to the donee upon his attainment of age 21. If the donee dies before reaching age 21, such unexpended income and principal must be paid either to the donee's estate or as the donee might appoint. The trust can provide that when the minor reaches age 21 he has a limited period in which he can force immediate distribution of the trust fund. If such power is not exercised, the trust can continue on its own terms.
If the foregoing requirements are met, the donor of the trust is allowed the advantage of an Internal Revenue Code gift tax provision that has become a familiar feature of gift-giving programs. A donor is permitted to exclude from the total gifts made in the tax year the first $10,000 of a gift made to an individual. If the donor's spouse joins in the gift (the spouse need not have any interest in the property being transferred), the exclusion is $20,000. Stated simply, either $10,000 or $20,000 worth of property can be transferred by a donor free of federal gift tax to a single individual in a given tax year. Such a gift can be repeated in each succeeding year.
In regard to the gift tax exclusion where the transfer is in trust, the exclusion applies only to the transfer of a "present interest." A right to a distribution of trust principal at the termination of a trust constitutes a future and not a present interest. Were it not for the special dispensation given in the case of a trust for the benefit of a minor, a transfer to such a trust would typically not qualify for the $10,000/$20,000 exclusion because the transfer would not be of a present interest.
The Internal Revenue Code, however, eliminates the "present interest" requirement where the trust is for the benefit of a minor and the requirements described above are satisfied. Thus, if amounts no greater than the annual exclusion are given to the trust for the benefit of a minor each year, such transfers would escape gift tax and would not be subject to estate tax upon the donor's death. The donor's appointment of himself as trustee would not negate the tax benefit.
Trusts and other estate planning instruments require careful planning and knowledge of the law. Always consult a qualified professional for advice on estate planning issues.