by Genevieve M. Moore, Morrison & Foerster LLP
Like many estate planners, we were kept very busy in the last quarter of last year, assisting clients who could take advantage of 2012's large per-person federal gift tax exemption and low gift tax rate. Therefore, this monthly posting will be a short one that alerts practitioners to certain issues regarding custodial accounts for minors.
Custodial accounts are generally creatures of state law under the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) laws of each state, but they can have certain federal tax consequences as well. These should be considered when a donor establishes a custodial account for a minor.
First, if a parent creates a custodial account for a minor, and acts as the custodian, the custodial property may be included in the parent's gross estate if the parent dies while the custodial account is in existence. This is because under the law, as enacted by various states, the donor-custodian has the power to pay or withhold account income and principal. This retained power can cause estate inclusion in the donor's estate under Internal Revenue Code ("I.R.C.") Section 2038(a)(1).
Second, a custodial account created by a parent for minor child may be subject to inclusion in the parent's gross estate under I.R.C. Section 2036 if the income from the account is to be applied to the parent's legal support obligations. Under Treas. Reg. § 20.2036-1(b)(2), the custodial property can be included in the parent's gross estate if the "use, possession, right to the income, or other enjoyment is to be applied toward the discharge of a legal obligation of the decedent, or otherwise for his pecuniary benefit. The term 'legal obligation' includes a legal obligation to support a dependent during the decedent's lifetime." Moreover, if custodial income is actually used to discharge the parent's legal support obligations, the parent will be taxed on the income for federal income tax purposes. I.R.C. Section 677(b).
Third, even if a parent is named custodian of an account for his or her child that was established by another person (e.g., a grandparent), there can be federal estate tax consequences and income tax consequences to the parent. As above, if the custodial income is used to discharge the parent's obligation to support the minor, the parent may be subject to income tax under I.R.C. Section 677(b). Also, if the parent dies while the custodial account is in existence, the parent's broad powers over the custodial account - which are not limited by an ascertainable standard - can cause the account to be included in the parent's taxable estate under I.R.C. Section 2041.
Some states permit custodial accounts to continue beyond the minor's attainment of age 18 (e.g., to age 21 or 25), so the issue does not necessarily disappear when the minor reaches age 18. Also, those states may impose legal support obligations for college-age children. The scope of support obligations varies from state to state, and often from family to family depending on the parents' particular financial circumstances. These issues are worth checking before a parent is designated as the custodian of a minor's property. In accounts for which a parent is already acting as custodian, consideration should be given to whether the donor parent should resign in favor of the other parent or another person. Keep in mind though that resigning as custodian may be deemed to be the release of a general power of appointment, requiring survival for three years to ensure that the account is not included in the parent's gross estate.
Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients. If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.
© Copyright 2013 Morrison & Foerster LLP. This article is published with permission of Morrison & Foerster LLP. Further duplication without the permission of Morrison & Foerster LLP is prohibited. All rights reserved. The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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