Are you a parent with minor children? Maybe a single parent? Are you unmarried but living with your child’s other parent? A grandparent looking to provide for your grandchildren? Someone looking to provide for a child during life or after you pass? Whether you’re looking to gift to your children or grandchildren; help with their education and/or medical expenses, or are concerned about what happens to your children if you were to suddenly pass.
Before we begin, please remember: gifts do not offset your legal obligation and responsibility to support and care for your minor child(ren).
In this article, we will take a look at:
How could a minor receive an inheritance?
There are many ways in which a minor could end up inheriting from a parent, grandparent, or other family member. Some of those scenarios include:
- Direct gift (either during lifetime or through a will or trust)
- A single parent who passes away
- Both married biological parents passing away simultaneously in a common accident
- Passing away after a divorce and not remarrying
- A grandchild could inherit if an adult child passes away
With most of these scenarios, the minor is inheriting through intestacy – the statutory procedure for distributing assets when one dies without a will. With proper estate planning, it is possible to avoid intestacy. For more on intestate succession in Massachusetts read our blog Massachusetts Intestacy: What Happens When You Die Without a Will?
Common Law Marriage in Massachusetts and New Hampshire
Common law marriage is a legal marriage where the couple never got formally married and never obtained a marriage license or certificate. For states that recognize it, there are requirements for proving a common law marriage, and typically cohabitation is not enough. Whether common law marriage is recognized in a state can have implications on inheritance.
Common law marriage is not recognized in Massachusetts. This means that if two people are cohabitating, have minor children, and one of the parents passes away, the estate of the deceased parent would flow through to the minor child, not the surviving parent. Your long-term, live in, boyfriend/girlfriend, has no legal interest in your estate, regardless of whether you share a child.
In New Hampshire, “common law marriage” does not appear in the statutes, however, New Hampshire law does provide that
“[p]ersons cohabiting and acknowledging each other as husband and wife, and generally reputed to be such, for the period of 3 years, and until the decease of one of them, shall thereafter be deemed to have been legally married.”
New Hampshire RSA 457:39
Essentially this means that New Hampshire will recognize a version of common law marriage for inheritance purposes only. This could mean that if you satisfy the statutory requirements, upon the death of one of the partners, the couple will be deemed to have been married. For gifts and inheritances to minors, if this New Hampshire couple has minor children, the money, assets, and property of one of the parents in a situation like this, could end up bypassing the minor child and becoming the property of the other partner/parent. Depending on the situation, this could be a good thing, or a bad thing.
Types of Gifts to Minors
We will take a look at a few options available for gifting to minors:
- Outright gifting (including inheritances)
- Uniform Transfers to Minors Act (UTMA) Accounts
- 529 Plans
- Trust planning
However, before we discuss those options, it is important to review some tax considerations including the gift tax, generation skipping tax, and income tax. There are certain payments and contributions that would be excluded from gift tax.
Tax Considerations
Gift Tax
When gifting, there are two exclusion amounts: an annual gift tax exclusion amount, and a lifetime exclusion amount. For 2024, the annual gift tax exclusion amount is $18,000. This means that you are allowed to gift each recipient up to the annual exclusion amount ($18,000 in 2024) tax-free. You are allowed to make as many gifts each year, up to $18,000 per person, that you’d like. Once a gift to one person exceeds the annual exclusion amount, you either pay the gift tax, or you can eat into your lifetime exclusion amount, and the gift is tax-free.
It is important to note that the federal estate tax exemption and the lifetime gift tax exemption amounts are ONE exemption (for 2024 $13.61 million). This means that if you avoid paying taxes on an otherwise taxable gift by eating into your lifetime gift tax exclusion, you are reducing your federal estate tax exemption amount.
Unlimited Gift Tax Exclusion for Qualified Education and Medical Expenses
Are you looking to help your child or grandchild pay for college or with their medical bills? There is an unlimited gift tax exclusion for payments made directly to an institution or person furnishing education or medical services to another person. This bears repeating: In order for these payments to qualify for the unlimited gift tax exclusion, they must be made directly to the school or medical facility. Reimbursements to the student or patient do not qualify.
There are additional rules regarding the application of this exclusion pursuant to 26 CFR 25.2503-6.
- Education Expenses:
- Limited to tuition for full-time and part-time students. Tuition is amount of money required for enrollment in the school. 26 CFR 25.2503-6(b)(2)
- Books, supplies, room and board, and other similar expenses are not covered by this exclusion.
- Medical Expenses:
- Pursuant to 26 CFR 25.2503-6(b)(3), the exclusion applies to payments for:
- The diagnosis, cure, mitigation, treatment or prevention of disease,
- The purpose of affecting any structure or function of the body, or
- Transportation primarily for and essential to medical care.
- Additionally, payments for medical insurance are covered. However, the unlimited exclusion from the gift tax does not apply to amounts paid for medical care that are reimbursed by the donee’s insurance.
- It also covers long-term care services, such as the costs of nursing homes or assisted living facilities, if provided by a licensed health care provider.
- Cosmetic surgery is generally not covered unless to correct a birth defect or disfigurement from injury or disease.
Generation Skipping Tax
If you are a grandparent providing for your grandchild(ren) after your death, you may run into the generation skipping tax (“GST”). The GST is imposed on transfers to “skip-persons” (this usually ends up being grandchildren).
The GST technically applies to transfers to anyone more than 37.5 years younger than the donor, or to family members more than one generation younger than the donor (grandchildren, etc.).
Unlike the gift tax, the GST is a SEPARATE federal transfer tax, with its own exemption amount. It is a flat 40% tax rate. The GST exemption does, however, mirror the federal estate/gift tax exclusion amount, and is also going to sunset after 2025. For 2024, the GST exclusion amount is $13.61 million dollars.
Income Tax
Gifting to minors also requires some income tax considerations.
If you gift or bequeath income producing property to a minor, you could be shifting the property from your income tax bracket to the minor’s lower income tax bracket. Although this seems like benefit, there are some exceptions and possible adverse considerations as well.
KIDDIE TAX: The IRS created the Kiddie Tax rule to prevent parents or guardians from transferring large assets to minors to take advantage of their lower tax rate. It applies to children with unearned income (gains, dividends, interest) under 18, and dependent students between 19 and 24 years old. For 2023, the first $1,250 of unearned income is tax-free, the next $1,250 of unearned income is taxed at the minor’s rate, and any unearned income above $2,500 will be taxed at their parents marginal rate. The parents are responsible for paying this tax.
Outright Gifts to Minors
The first, and probably most obvious, way of providing for minors is through outright gifting. This could be through lifetime gifts, or inheritance through a beneficiary designation, will, or intestate succession.
Minors are legally incompetent and cannot hold assets on their own until they turn 18. If property is left to a minor in a will without naming who will be in charge, or if a minor inherits through intestacy, in order for the minor to “take possession” of the assets/property, a petition to appoint a guardian or conservator would need to be filed in court. The guardian/conservator does not take ownership of the minor’s assets, and has a fiduciary duty to act in the best interest of the minor until they turn 18 years old.
Outright gifts may be a quick, easy, or maybe even default way of providing for minors, however, they may not be the best option or the most efficient means of doing so. Further, outright gifting does not come without drawbacks, including:
- The donor loses control over the gifted property,
- The minor can face some serious capital gains tax issues. With outright gifting (NOT an inheritance), the beneficiary does not receive a step-up in basis; their basis for capital gains tax purposes would be your original cost basis when you purchased or acquired the property (for example, a home or stocks).
- Typically for inheritances, the beneficiary – whether a minor or adult – would receive a basis step-up to the date-of-death value. See 26 CFR 1.1014-2.
- Depending upon the age of the minor, he or she may fail to appreciate, or otherwise squander, the money/assets/property. The property would also be subject to creditors of the minor. This is why wills and trusts include spendthrift provisions.
Uniform Transfers to Minors Act (UTMA) Accounts
Accounts under the Uniform Transfers to Minors Act (“UTMA”) are taxable investment accounts set up to benefit a minor, and are controlled by an adult custodian (parent, guardian, relative, godparent, friend, etc.) until the minor reaches the statutory age of majority in their state (21 in MA and NH).
The original Uniform Gifts to Minors Act (“UGMA”) only allowed for financial assets to be placed in a UGMA account. The UTMA expanded these rules, and can be funded with physical assets as well. Gifts to an UTMA account in excess of the annual gift tax exclusion will be subject federal gift tax. There are no contribution limits. UTMA accounts can be funded by anyone, either through a direct gift or estate planning documents, with property including:
- Cash;
- Stocks, bonds, ETFs, mutual funds, and other investments;
- Insurance policies;
- Real Estate;
- Silver, gold, and other precious metals, and
- Art
Taxation of UTMA Accounts
Contributions to UTMA accounts are made with after-tax dollars. Investments in an UTMA account are not tax exempt, and the minor is responsible for paying taxes on any income generated from the account, as they are the owner of the UTMA account. Income could be from interest, dividends, or capital gains from selling an asset for a profit. The first $1,250 of income is not taxed. The next $1,250 is taxed at the minor’s rate. Income over $2,500 is taxed at the parents’ rate under the kiddie tax.
Benefits of UTMA Accounts
- Contributions to UTMA accounts are irrevocable, which means they benefit a donor by reducing their total taxable estate for state and federal estate tax purposes.
- UTMA accounts provide flexibility to the minor beneficiary because the property does not need to be used for educational purposes; upon reaching the age of majority, the beneficiary can use the funds for anything they want.
- The UTMA allows minors to receive or inherit gifts, without the need for a court appointed guardian or conservator, nor does it require a trustee through a trust.
- Contributions to an UTMA account are made with after-tax dollars, so withdrawals are generally tax-free.
- The custodian owes a fiduciary duty to manage and invest the property for the minor, and can only withdraw funds for the benefit of the minor.
- UTMA accounts keep money out of the hands of the minor until they reach the statutory age of majority, which for Massachusetts and New Hampshire is 21. This is a benefit over outright gifting in which the minor receives the funds at 18.
Drawbacks of UTMA Accounts
- Gifts made to an UTMA account are irrevocable. This means the donor loses control over the property and cannot take it back.
- If a parent/donor is also custodian of the UTMA account, then even though the property transferred to the UTMA account is considered a completed gift, it may still be rolled back into donor’s estate upon the death of the parent donor.
- UTMA accounts can only benefit one person. There is no “spray” feature.
- Even though a custodian has a fiduciary duty to use funds in the best interest of the minor, there is always the possibility that the custodian may misuse the funds. This is why it is important to name a trustworthy individual to be custodian.
- The account is set up using the minor’s name and Social Security number, and the property immediately belongs to the minor (even though a custodian manages the account). This will have an impact on student aid and/or scholarships.
- When the beneficiary reaches 21 years old, they have immediate, unfettered, access to the UTMA property. Depending upon their maturity they may fail to appreciate, or otherwise squander, the property.
- Once the minor reaches age of majority and the custodianship ends, the funds become exposed to their creditors, potential divorce, and bankruptcy.
More information on the Massachusetts Uniform Transfers to Minors Act can be found in G.L. c. 201A.
More information on the New Hampshire Uniform Transfers to Minors Act can be found in RSA C. 463-A.
UTMA accounts can be a better option for providing for minors than outright gifting. However, they don’t come without drawbacks. Many of these drawbacks can be addressed through trust planning, which may be a better option than UTMA Accounts. If you are certain that the funds will be used for educational purposes, a 529 plan may be a better option. We will discuss 529 plans and trusts below.
529 Plans
A 529 Plan is a tax-advantaged savings plan to help pay for a beneficiary’s qualified education expenses.
These accounts can be used for kindergarten through 12th grade, college, certified apprenticeship programs, and qualified student loan repayments.
There are many rules, regulations, contribution minimums and limits, and other requirements for 529 plans which should be discussed with a financial advisor and/or accountant. For purposes of this article, 529 plans are an available option for providing for a minor’s educational costs. Most states offer different 529 plans, and you are allowed to shop around for the best plan for you; you are not required to use the plans of the state you live in nor where the beneficiary will be going to school. There are two types of 529 plans:
- College Savings Plan:
- Investments grow tax-free, and can be withdrawn tax-free for qualified educational expenses including for tuition, room and board, and textbooks.
- Pre-Paid Tuition Plan:
- Allows you to pre-pay all or part of a locked-in in-state tuition.
Gifts to 529 plan accounts are irrevocable, but the donor can retain an unusual amount of control over the account. The donor can control how funds are invested, when funds are distributed out, and they can even reacquire the funds (but there tax consequences in doing this). If the beneficiary dies prior to distributions being made, the amount is included in the beneficiary’s gross estate. There is no mandatory distribution age as there is in an UTMA account.
Massachusetts 529 Plans
Massachusetts offers both a 529 college savings plan (MEFA U.Fund) and a pre-paid tuition plan (U.Plan). The Commonwealth also provides a state tax benefit. More information about the Massachusetts 529 plans can be found here (again, discuss with a knowledgeable financial/tax advisor):
MEFA U.Fund 529 College Savings Plan
MEFA U.Plan Prepaid Tuition Plan
New Hampshire 529 Plan
New Hampshire offers a 529 college savings plan: The UNIQUE College Investing Plan.
For more information on 529 plans, many have found this website to be a helpful and informative resource: savingforcollege.com.
Trusts for Minors
Trusts documents establish a legal entity that creates a fiduciary relationship in which a trustee holds assets of the grantor (the person funding the trust) for the benefit of the beneficiaries.
The beneficiaries of a trust receive the property pursuant to the terms of the trust as desired by the grantor.
Trusts can provide a great level of flexibility and allow a grantor to place restrictions on when and how a distribution can be made to beneficiary. For example, a grantor can provide that the beneficiary can have immediate access to the income and/or principal of the trust, or that the contents of the trust will be distributed when the beneficiary reaches a certain age. To learn more about trusts, read our article: Overview of Basic Trusts and Their Functions.
For trusts inherited by minors, remember to keep money in an account to pay for any taxes/bills that come up especially for real estate. There are many different types of trusts that can be established to meet any number of goals. Some of the more popular options are living trusts, 2503(c) trusts, and “Crummey” trusts. This, of course, is not an exhaustive list.
Living Trust
A living trust is probably the simplest and most “standard” of the trusts to deal with. A living trust is revocable, which means it can be amended or revoked by the grantor at any time during the grantor’s life. This trust is a vehicle to hold property and asset for the benefit of a beneficiary, managed by the trustee.
The grantor of the living trust can be the initial trustee. Upon the death of the grantor-trustee a successor trustee will serve and manage the trust property pursuant to the terms of the trust.
A living trust is probably the simplest and most “standard” of the trusts to deal with. A living trust is revocable, which means it can be amended or revoked by the grantor at any time during the grantor’s life. This trust is a vehicle to hold property and asset for the benefit of a beneficiary, managed by the trustee. The grantor of the living trust can be the initial trustee. Upon the death of the grantor-trustee a successor trustee will serve and manage the trust property pursuant to the terms of the trust.
A living trust provides a grantor a flexible means of transferring property allowing them to place restrictions on when and how a distribution can be made to beneficiary. Due to living trusts being revocable, however, they will not provide a grantor with a means of taking advantage of the gift tax exclusion because the property still belongs to the grantor, and in order to take advantage of the gift tax exclusion, the recipient has to be able to use the gift immediately.
For a grantor that wishes to take advantage of the gift tax exclusion, that’s where the 2503(c) and Crummey trusts come into play. Note that in order for these trusts to qualify for the gift tax exclusion, they must be irrevocable. There are many rules and regulations for these, and other trusts, and we won’t get lost in the weeds with all of that here.
- For both 2503(c) and Crummey trusts, if the donor also acts as the trustee, the trust property will be included in their gross taxable estate. Typically a third-party trustee would be appointed for these trusts.
- The main difference between a Crummey trust and a 2503(c) trust is that a Crummey trust does not need to terminate when the beneficiary turns twenty-one, whereas the 2503(c) trust does.
2503(c) Trust
So named after 26 U.S. Code § 2503(c). These are irrevocable trusts in which qualify for the annual gift tax exclusion under 26 U.S. Code § 2503(b) by following these requirements:
- The property and the income may be paid to or for the benefit of a single donee prior to their attaining twenty-one years of age, with limited restrictions and discretion;
- The property will pass to the donee upon the donee reaching age twenty-one; and
- If the donee dies before reaching the age of twenty-one, the property will be payable to their estate or as they may appoint under a general power of appointment under I.R.C. § 2514(c) If the donor dies prior the trust terminating, the trust will continue.
“Crummey” Trust
It’s not a Crummey trust because it’s not that good…or because it has anything to do with baked goods – it’s so named after a case that the trust powers come from: Crummey v. Commissioner , 397 F.2d 82 (9th Cir. 1968). These trusts can be set up for one or more beneficiaries, and withdrawals DO NOT need to be made at 21 years old.
A Crummey power is a right given to a beneficiary to withdraw property upon its addition to a trust, in an amount often equal to the lesser of a pro rata share of the gift and the maximum gift tax annual exclusion. This allows the trust to qualify for the gift tax exclusion.
The problem with Crummey trusts is that if the beneficiary withdraws a large sum of funds, it could threaten the point and viability of the trust.
As with all things in life, there are advantages and disadvantages, pros and cons, to every estate planning decision. For a personalized review of your current estate, and/or to discuss the best options to provide for the children in your life, schedule a free consultation to discuss estate planning options, and determine what plan will be best for you and your family.
No information in this blog post is to be construed as, nor is intended to be, legal, financial, nor tax advice. Consult with competent legal counsel and/or tax/financial professionals prior to taking any action. Do not rely on any information contained in this blog post as the law changes from time-to-time and this blog post may not be updated to reflect those changes.
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