In this article, we’ll define a 2503(c) Minor’s Trust, review the advantages of a 2503(c) Minor’s Trust and disadvantages of a 2503(c) Minor’s Trust, and explain the tax benefits of Minor’s Trusts.
Named after the section of the Internal Revenue Code that sets the requirements for the irrevocable trust, the 2503(c) Minor’s Trust is utilized to hold gifts in trust for a child until he or she is 21 years old. This trust only has one beneficiary, who has to be a minor (an individual younger than 21).
Once the beneficiary turns 21, he or she has complete control over the trust’s assets. The grantor, or creator of the trust, cannot receive any income generated by the trust’s assets. Typically, the grantor makes annual contributions to the trust in an amount equal to the annual exclusion amount (currently $13,000). Although the trust can continue to exist after the beneficiary turns 21, his or her gifts will no longer qualify for the annual exclusion. For a gift to qualify for the annual $13,000 gift tax exclusion, the recipient has to be able to use the gift immediately.
A 2503(c) Minor’s Trust qualifies for the annual gift tax exemption if it follows these requirements:
Minor’s trusts are often used for parents and grandparents to save for a child’s college education, because it’s an easy way for grantors to gift assets to a minor while still qualifying for the federal gift tax and generation-skipping transfer tax exemptions. The beneficiary’s trustee can pay the child’s college expenses from the 2503(c) until the minor turns 21. The trustee has to be someone other than the grantor, such as the grantor’s spouse or family member. If the grantor is also the trustee, adverse estate tax consequences may arise. Until the minor becomes of age, the trustee has the right to remove any assets or property from the trust.
For these reasons, it’s common for grantors to combine 2503(c) Minor’s Trusts and Crummey Trusts into a hybrid trust that acts as a 2503(c) Minor’s Trust until the beneficiary turns 21, then transforming into a Crummey Trust. This method allows annual gifts to the trust to continue to qualify for the gift tax exclusion after the minor turns 21. Grantors are often worried the minor will be too young at the age of 21 to make a rational, long-term decision with the trust’s assets. To combat this concern, grantors can restrict the beneficiary’s right to the money until 30, 60, or 90 days after the child turns 21. If the minor chooses to defer his or her right to the money during this time period, the money will remain in the trust until a specified date in the trust document. If the beneficiary decides to remove all of the trust property once he or she is of age, the trust will be terminated.
When it comes to the income tax aspects of a 2503(c) Minor’s Trusts, all of the income that accrues inside the trust will be taxed to the grantor. The beneficiary will be taxed on the distributions made from the trust to the beneficiary at the beneficiary’s tax rates. However, distributions to a beneficiary under the age of 19 are subject to be taxed at the child’s rates, under which the income may be taxed as if it is taxable income to the beneficiary’s parent. Once the beneficiary turns 21, he or she is the legal owner of the trust and will be taxed on all trust income, regardless if it is retained or distributed. Be sure to consult your tax professional about the tax consequences of establishing and funding a minor’s trust.
If income from the trust pays life insurance premiums on a policy where the donor or the donor’s spouse are the insured or uses the income to pay for parental obligations or other legal obligations of the donor, the donor has to pay taxes on the income. Similarly, if the donor reserves the right to receive income from the trust, the donor has to pay taxes on the income.
While these trusts may sound appealing to parents, the Uniform Gift/Transfer to Minors Act also acts as a child’s asset for financial aid purposes, having a high impact on need-based financial aid eligibility; majority of the time, parents are better off establishing section 529 plans for their children. Due to the specific provisions a minor’s trust is required to abide by regarding U.S. tax laws, it is one of the most complicated kinds of trusts for a lawyer to draft. Trustees of the trust also need to receive guidance from an attorney to ensure compliance with the terms of the trust.
If you have questions about 2503(c) Minor’s Trusts, or if you need help drafting a 2503(c) trust document, contact us today. For an Estate Planning attorney, you can reach out to us at O’Flaherty Law by calling 630-324-6666, emailing firstname.lastname@example.org or visiting out website, www.oflaherty-law.com where you can schedule a free initial consultation.