Parents and grandparents who wish to make gifts to minor children and grandchildren are sometimes advised to set up Uniform Transfer to Minors Act (UTMA) accounts for them. (Under prior law,these were known as Uniform Gifts to Minors Act accounts.) In certain instances, these accounts may have unfortunate tax and practical consequences.
Since the assets of a UTMA account may be used to pay expenses of the child which a parent is otherwise obligated to provide (such as medical or educational expenses), if the parent is a custodian, he or she will be considered to have a general power of appointment over the account under Treasury Regulation §20.2041-1(c). Property over which a decedent has a general power of appointment is included in the decedent's federally taxable estate. Thus, if the child's parent is the designated custodian of such an account, and the parent dies, the account will be included in the parent's estate for federal estate tax purposes.
Furthermore, if the parent contributes money to a UTMA account for his or her child, and the parent is also the custodian of the account, the contribution may be an incomplete gift for gift tax purposes under Treasury Regulation § 25.2511-2(b); from a gift tax perspective, the transaction will be a nullity. When the gift becomes complete, i.e., upon the child reaching age 21, his gift may not be fully sheltered by the available annual exclusions. Therefore, as a general rule, a parent should not be the custodian of his or her child's UTMA account.
An individual is absolutely entitled to all of his or her UTMA account at age 21 (and, in some instances, at age 18). The account may have a very substantial balance at that time. If significant amounts are going to be set aside for the child, it will be better to instead establish a trust for the child. A trust can be created for a minor under Internal Revenue Code Section 2503(c) so that contributions to that trust will qualify for the $10,000 per year annual gift giving exclusion. These trusts must give the child some opportunity to withdraw the trust property at age 21, but that opportunity can be limited. Other trust arrangements, sometimes referred to as "Crummey trusts", may provide a preferable alternative in certain cases. In general, a trust should be considered in all instances where regular annual exclusion gifts are contemplated.
