A trust is a legal arrangement where a separate legal entity is created (the "trust") and the person making the trust (the settlor or grantor), transfers ownership of property to a trustee. The trustee, in turn, is responsible for investing the property for the benefit of a third party (the beneficiary) named by the settlor.
Some trusts are called testamentary trusts because they are usually made as part of a will and don't go into effect until the will is probated. One of the most common testamentary trusts is the minor's trust, or a 2053(c) trust.
A minor's trust is used to hold assets, like money or property, until the minor reaches the age of 21, if that what the trust allows.
There are several requirements that must be met in order for a minor's trust to be valid. If you're considering such a trust, read the federal tax laws carefully, or seek the advice of an experienced tax attorney or estate planning attorney.
How the Minor's Trust Works
Generally, under section 2053, a parent can make a gift to children per year. This is called the gift tax exemption. For 2009, gifts of up to $13,000 don't have any tax consequences: the parent doesn't get a deduction, and the child doesn't have to report it as income.
Nonetheless, there is an estate planning benefit for the parent: the gifts lower the parent's estate - the property or assets that are left, so the estate tax is reduced when the parent dies. But, to qualify as a gift, the child must be given immediate access to and control over it.
Normally, a gift of $13,000 to a child held in a trust until age 21 won't qualify as a section 2503 gift because the child doesn't have immediate access to it.
With a valid minor's trust, gifts to the trust will be treated as a gift to the child and qualifies for the annual $13,000 gift tax exemption, even though the child won't receive the funds until 21 years old.
Making a Valid Minor's Trust
Qualifying as a minor's trust under section 2503 a trust agreement or "trust instrument" is created, and must provide that:
- The minor is the only beneficiary of the trust. However, the trust can state that if the child dies before turning 21, unless the child gave away the trust assets in the will, then the trust assets can be paid to or held in trust for others, such as the child's brothers and sisters.
- Any income the trust makes and the original assets transferred to the trust are given to the child at age 21.
- That child has the right to give away the trust assets in the event that he or she dies before 21, that is, the child can make his will and state that the trust is to go to his sister, for example, if he dies before he's 21.
Age 21 isn't generally regarded as a sensible age to hand over large sums of money to a child. Many trusts state that upon reaching age 21, the child will be notified the trust assets can used. If that right isn't exercised within a certain time, usually 30 or 60 days after being notified (the "notice window"); the funds remain in the trust outside the child's control for a specified time, usually 5 to 10 years.
Some Things to Consider
If you're a parent, it's generally not a good idea for you to be the trustee of minor's trust for your child. There is a possibility the trust assets could be included in your estate if you die before the trust ends. On the other hand, if you live until after the child turns 21 and you're not the trustee, the trust assets and income are not included in your estate.
Until the child turns 21, any income during the year held in the trust and not given or "distributed" to the child during that year is taxed to the trust. Income distributed to the child is taxed to the child. There is no additional tax when the trust ends and the assets are given to the child. If the child dies before the trust ends, the assets are taxed to the child's estate.
If the trust provides for a "notice window" and the trust continued for a 5-10 year term, as in the example above, the child is taxed on all trust income and capital gains, whether or not it was distributed. It's a good idea to require the trustee to pay the child an amount equal to any tax liability for the year.
Questions For Your Attorney
- Can both me and my wife give money to Minor's Trust for our child? If so, how much can we give?
- I have land that is worth far more than $13,000. How can I give that to a Minor's Trust but still take advantage of the IRC § 2503 gift exemption?
- Can I give money to my grandchild's Minor's Trust? If so, how much can I give?