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FOR IMMEDIATE RELEASE: June 30, 2003

WANT TO SECURE YOUR CHILD’S FUTURE? PUT YOUR FAITH IN A TRUST

Parents and grandparents wanting to make a substantial gift to a child should consider establishing a trust, recommends the New York State Society of CPAs. Trusts offer tax advantages and flexibility. For example, you can set up each trust to achieve a specific purpose and specify when the children actually gain access to the funds. Thus, you can be generous without giving up control.

Tax implications

A trust creates a separate taxpayer, with its income taxed to the trust. The child pays income tax only on the trust income actually distributed to him or her. This is especially important if other assets owned by the child push his or her income into a high tax bracket.

For 2003, taxpayers are allowed to give an individual up to $11,000 ($22,000 for married couples), without incurring any gift tax, for gifts of “present interest.” The present interest requirement means that the recipient must be able to use the property immediately. Under most circumstances, a gift made to a trust for the benefit of a minor would not be considered a gift of “present interest” and, as such, would not be eligible for the annual gift tax exclusion.

The law recognizes that giving such a large sum to a child would not be prudent. There are, therefore, three notable exceptions to the present interest rule: the Section 2503(c) Qualifying Minor’s Trust; its close counterpart, the Section 2503(b) Trust; and the Crummey Trust. CPAs point out that gifts to these particular types of trusts may qualify for the gift tax exclusion even though most gifts in trust do not. Here’s how they operate.

Section 2503(C) qualifying minor’s trust

The Section 2503(c) Qualifying Minor’s Trust is named after the section of the Internal Revenue Code upon which it is based. Under Section 2503(c), a gift to a trust established for a minor qualifies for the gift tax exclusion if the child has the right to withdraw the money at age 21. However, a child can be granted the right to continue the trust term beyond age 21.

This trust essentially enables a parent or grandparent (or any other individual) to transfer property that would be subject to income or estate taxes into a trust that is taxed separately. The principal and any interest earned can be used for the child’s benefit, such as college expenses.

In order to be a valid 2503(c) Trust, the trust must meet these additional requirements: (1) the trust must have only one beneficiary; (2) the principal and income of the trust must be available to the trustee for the benefit of the child during the term of the trust; and (3) if the child dies before age 21, the assets must be distributed to his or her estate.

SECTION 2503(b) QUALIFYING MINOR’S TRUST

This variation of the 2503 Trust creates a “present interest” by requiring that all income from the trust be distributed annually. The distribution of income can be made to the child directly or to a custodial account where it can be accumulated or used for the child’s benefit. The principal can be held in the trust until after the child reaches age 21.

The key difference between a 2503(c) Trust and a 2503(b) Trust is the distribution requirement. Parents who are concerned about providing a child or another beneficiary with access to trust funds at age 21 might be better off with a 2503 (b), since there is no requirement for access at age 21. In fact, assets may be held long into the child’s adulthood. The main disadvantage to a 2503(b) is that the annual distribution requirement may limit growth of the trust principal.

Crummey trust

The Crummey Trust, named for the man who invented it, is an irrevocable trust that permits greater flexibility in designating when trust assets will be distributed to the child. Any time you give property to the trust, the beneficiary must have the right to withdraw the contribution during a brief time period, typically 30 to 60 days. Thus the child does not have to wait until he or she reaches age 21 to use the trust funds. The right to withdraw the contribution converts the gift to one of present interest, thereby ensuring that the gift qualifies for the gift tax exclusion, even if not exercised by the child.

If the child does not withdraw the gift within the prescribed window, the withdrawal right is revoked and the money remains in the trust until the child reaches the age specified. Parents, grandparents or others who are trustees of the account can use the trust’s income for other purposes, such as paying the premiums of a life insurance policy or meeting their child’s education expenses.

Unfortunately, these trusts have high administrative costs and the trust is treated as an asset if a child seeks financial aid for college. Keep this in mind as you evaluate your needs.

SEEK EXPERT ADVICE

Trusts provide an excellent way to plan for a child’s financial future while saving on taxes. A CPA can provide advice concerning the tax implications of setting up a trust. Be aware that setting up a trust requires the services of an attorney and that, going forward, there will be ongoing expenses for trust administration and tax return preparation.

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PUBLIC SERVICE ANNOUNCEMENT
TRUST FUNDS CAN HELP YOU SAVE FOR YOUR CHILD’S EDUCATION
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Trust funds can be a tax smart way to save and pay for your child’s education. The New York State Society of CPAs says gifts made to three types of trusts – a 2503(c), 2503(b), and Crummey Trusts – qualify for the annual gift tax exclusion. For 2003, parents or other individuals can contribute up to $11,000 ($22,000 for married couples) to these trusts without incurring any gift tax.

Depending on the type of trust, the fund’s income and/or principal can be used for the child’s benefit, such as for college expenses. The structure and terms of the trust determine whether the income will be taxed to the trust, beneficiary, or the individual who created it. Generally any income distributed to or for the benefit of the minor will be taxable to the beneficiary. A CPA can advise you on the type of trust that would best meet your needs, as well as on the associated administrative costs.