Can I transfer ownership of assets to my child who is a minor to avoid or reduce my tax liability?

Parents of minor children often wonder if they can reduce their tax liability by transferring ownership of their assets to their minor children, who reside in a much lower tax bracket. Whether this strategy is beneficial depends largely on the value of the parent’s assets and the age of the child. Sometimes the costs affiliated with setting up the transfer and management of the property until the child reaches adulthood can outweigh any tax benefits enjoyed by the parents. For instance, transferring assets to underage children can affect their ability to qualify for financial aid when applying to college.

Laws Affecting Asset Transfers to Minor Children

Two laws govern the transfer of assets to a minor, the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA). All states have now adopted the UTMA except Vermont and South Carolina, which continue to follow the UGMA. UGMA and UTMA accounts are similar, but the types of assets that can be transferred into each of these accounts differ. In a UTMA account, ownership of any kind of asset (including real estate) can be transferred to a minor. On the other hand, assets in a UGMA account are limited to cash, securities, and insurance policies. Finally, note that while custodians, relatives, and even friends can both manage and contribute to either a UGMA or UTMA account, if the donor who created the account is also acting as the custodian and dies before ownership of the assets is transferred to the child, the account can be included in the donor’s estate and subjected to tax.

Watch for Limits on Tax-Free Unearned Income

Under both the UGMA and UTMA, minors can own securities in an account that is set up in their name without needing to create a special trust. Most parents set up UGMA or UTMA accounts as a way to pay for college for their children. The benefit of setting up these types of accounts is that the account is owned entirely by the child in the event the parent predeceases the child, so the assets will be available to the child when he or she reaches majority. The age of majority in this context varies depending on the state – 18 in some states and 21 in others.

Going beyond just a means to pay for college, parents thinking of lowering their own taxes by transferring income-producing assets to their children who are in a lower tax bracket should understand that federal law imposes limits on the amount that is tax-free or subject to a lower tax. Unearned income in UGMA and UTMA accounts, which includes interest, dividends, and capital gains, is taxed at different levels. Regardless of whether the child is over or under the age of 18, the first $1000 is exempt from taxes. The second $1000 will be taxed at the child’s tax rate regardless of age. Finally, if there is more than $2,000 of unearned income, this additional amount will be taxed at the child’s rate if the child is over 18. However, if the child is under 18 and there is more than $2,000 of unearned income, the additional amount will be taxed at either the parent’s tax rate or the child’s tax rate, whichever one is higher.

Gift Tax Consequences of Transfer of Income Producing Property to Minors

The gift tax will also come into play for parents considering transferring income-producing property to minors. Transfers to UGMA and UTMA accounts are considered gifts. Single taxpayers are permitted to make gifts up to $15,000 tax-free and married couples can make joint cash gifts of $30,000 tax-free. Parents are permitted to use the assets in UGMA or UTMA accounts, but only for the benefit of the child, so understand the limitations before using these accounts as a way to reduce or avoid taxes. A variety of avenues exist for reducing or avoiding tax liability by transferring assets to a child, but setting up the proper accounts and following the laws of the tax system can be complicated. For individual help, speak to an experienced tax attorney.

Case Studies: Transferring Assets to Minors for Tax Purposes

Case Study 1: Lowering Tax Liability

John wants to reduce his tax liability by transferring ownership of his income-producing assets to his minor child, who is in a lower tax bracket. He consults with a tax attorney to explore the feasibility of this strategy. Together, they analyze John’s assets, the child’s age, and the limitations imposed by the tax system to determine the effectiveness of this tax planning approach.

Case Study 2: Funding College Education

Lisa plans for her child’s future college expenses. She considers setting up a UGMA or UTMA account to transfer funds and assets. Lisa consults with a financial advisor and an estate planning attorney to understand the implications of such transfers. They discuss tax considerations, the age of majority, and the control Lisa will have over the assets until her child reaches adulthood.

Case Study 3: Gift Tax Considerations

Michael and Sarah aim to transfer income-producing property to their minor child to take advantage of lower tax rates. They consult with a tax attorney to navigate the complex gift tax regulations. The attorney explains the annual gift tax exemption and the limitations for married couples. Michael and Sarah weigh the potential tax savings against the gift tax consequences and work with their attorney to establish a strategy aligned with their goals.