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Making gifts into trusts: for minors.

Making a gift into trust for a minor can be a great family tax planning. idea. The reason behind this type of a transfer may be motivated by both financial and tax strategies. There are several special tax rules regarding this type of a gift, and if properly handled can save a considerable amount of income and gift taxes. Much of the tax planning can be achieved by a properly drafted trust instrument. The purpose of this article is to point out the rules involved with a gift into trust for a minor as well as looking at the tax planning opportunities and the potential pitfalls.

Annual Gift Tax Exclusion

A significant part of the strategy of transferring property into trust for a minor is to do so without paying any gift tax or using up any of the donor's unified credit. In order to accomplish this, the donor must be able to qualify for the annual gift tax exclusion of $10,000.(1) If a joint gift is made, up to $20,000 of the gift can be excluded. To qualify for the exclusion, the gift into trust must be a present interest. According to the Regulations, a present interest is an unrestricted right to the immediate use, possession or enjoyment of property or the income from property.(2)

IRC 2503(c) is an exception to the general rule that a gift of a present interest must be given to be able to claim the exclusion. Under IRC 2503(c), the donor can claim an exclusion. Under IRC even though the trust may accumulate income for a minor beneficiary. From a financial standpoint, this provision is very suitable for gifts into trust for minors, since there is a natural tendency to defer giving money to minors until they are old enough to be able to manage it.

To be able to claim the annual exclusion under IRC 2503(c), there are two conditions that must be met. First, the donee must be under the age of 21 when the transfer into trust is made. Second, any property and income which is not expended by or for the benefit of the minor by the time they have reached age 21 must be transferred to the donee. However, if the minor-donee dies before reaching the age of 21, such property and income must be payable to the estate of the donee or as they may appoint under a general power of appointment.

Unborn Children

A gift into trust for an unborn child does not qualify for the annual exclusion.(3) For instance, a donor has two children and creates three trusts in December of the current year. Two of the trusts are for the benefit of his then living children. The third trust is for the benefit of a child that is not born until January of next year. The donor can only claim the exclusion for the gifts into trust for his living children. The gift into the third trust for the unborn child is a gift of a future interest. Here, the strategy would be to make the gift into trust for the third child after it is born.

The Meaning of Property

IRC 2503(c) requires that both property and income be distributed to the minor beneficiary by the time he reaches age 21. The term property has been liberally interpreted. Suppose that the donor believes that the minor beneficiary will not be able to manage his own money when he reaches 21, so the donor has the trust drafted so that only accumulated income is distributed to the beneficiary when he reaches 21 and that the corpus will not be distributed until the beneficiary reaches age 30. Will the donor be able to claim the annual exclusion for the gift into trust? The Tax Court has established that accumulated income is a "property" severable from the corpus of the trust.(4) Accordingly, a trust may accumulate income on behalf of a minor beneficiary. As long as that accumulation is required to be distributed by the time that the beneficiary reaches age 21, such accumulation will be considered to be a present interest qualifying for the annual exclusion. However, it should be recognized that the corpus portion of the trust does not qualify as a present interest so that part of the transfer into trust will be considered a taxable gift.(5) Thus, only the income interest of the trust will qualify for the exclusion.


From a financial standpoint, if a donor desires to extend the ultimate distribution for the corpus beyond the 21st birthday of the beneficiary, he can do so at the price of having the corpus considered a future interest. This will cause a reduction of the unified credit, or perhaps the payment of gift taxes if the donor's unified credit has already been used up. In addition, it will cause the gift of the corpus to be added back to the donor's estate.(6) The donor may want to consider having the corpus distributed to the beneficiary by the time he reaches 21 to reduce gift taxes as much as possible, as well as making the ramifications of the gift as simple as possible. An earlier distribution of corpus to the beneficiary could even "force" him to become a responsible money manager.

Discretion of the Trustee

It is important to note that there must not be any substantial restrictions on the discretion of the trustee over the amounts distributed to a minor beneficiary.(7) Otherwise, gifts into trust for the benefit of a beneficiary do not qualify for the exclusion.

Reg. 25.2509-4(b)(1) requires that the trustee have the discretion to determine the amounts of income or property that is to be expended for the benefit of the minor and the purpose for which the expenditure is to be made. It has been established that if a trust empowers the trustee to use Income and property for a donee's "support, care, education, comfort and welfare" then there is no substantial restriction on the trustee's discretion since it would be considered for the benefit of the minor beneficiary.(8) The language in the trust instrument is very important and should be as objective as possible. However, if the general meaning of the trustee's power can be construed that income and property can be expended for the minor's "benefit," there will be deemed no substantial restriction on the trustee's power. For instance, the trust that was the subject of Rev. Rul. 67-270 provided for a minor's health or education and, additionally provided for trust property to be expended during the donee's minority for purposes which have no objective limitations (i.e., welfare, happiness and convenience). It ruled that when the provisions are read as a whole approximate the scope of the term "benefit," as used in IRC 2503(c), the transfer is deemed to meet the requirement that the property be expendable for the minor's "benefit."

Some trust instruments convey to a minor beneficiary the power to compel distribution of income or corpus upon attaining the age of 21. Is such a provision a substantial restriction on the trustee's discretion? In a private ruling, it was held that such a provision is not a substantial restriction on the trustee's discretion.(9)

Other trust instruments might impose a condition precedent on the trustee that amounts distributed for the benefit of a minor beneficiary be done so only after other sources of income are taken into account. In Rev. Rul. 69-345, the terms of the trust in question stipulated that the trust property may be used for the minor's benefit only in the event that his needs are not adequately provided for by his parents and only after his separate property has been expended. It was concluded that this type of proviso imposes a substantial restriction on the trustee's power to use the property for the minor s benefit. Even though such language may negate the ability of the donor to claim the annual exclusion, it tends to avoid grantor trust status under IRC 677(b) which imputes trust income to the grantor to the extent trust income is used for the support of a dependent of the donor. Without such a provision in the trust instrument, there would be a greater likelihood that trust income would be use to discharge the donor's support obligation thereby creating grantor trust status under IRC 677(b).

In the Faber case, the trust instrument provided that "any part or all of net income and accumulated income may be used in the sole discretion of the trustee, to provide for accident, illness or other emergency affecting the beneficiary (the child of the donor) until the child shall reach the age of 2l." It was held that the limitation upon the use of the trust income to provide "for accident, illness or other emergency affecting the beneficiary" constituted a substantial restriction upon the exercise of the trustee's discretion.(10) Again, we find that there is a trade-off between limiting the discretion of the trustee and being able to claim the annual gift tax exclusion.

Crummey Powers

Another degree off flexibility that can be added to a gift into trust for the benefit of a minor is the so-called "Crummey Powers." If a beneficiary of a trust receives a future interest, it will still qualify for the annual exclusion if the beneficiary is given the power to demand immediate possession and enjoyment of corpus or income.(11)

Extension of the Trust by the Minor


If the trust instrument gives the donee the power to extend the term of the trust, the donor will still qualify for the annual exclusion.j(12) This is an interesting provision, as it gives the planning of the gift into trust an extra degree of flexibility.

This particular type of proviso has been given a liberal interpretation. In Rev. Rul. 74-43, there was a gift into trust for the benefit of a minor, with the provision that the beneficiary has, upon reaching age 21, a continuing right to compel immediate distribution of the trust corpus by giving written notice to the trustee, or to permit the trust to continue by its own terms. It was held that this gift will not be considered to be a gift of a future interest as the gift satisfies the requirements of IRC 2503(c).(13) This gives a beneficiary who is deemed to be mature a chance to control his own financial destiny. That is, if the beneficiary would like to pay the costs of going to college, or needs a sum of money for a down payment on a home, he can demand a distribution. On the other hand, if there is no immediate need for money and the beneficiary would like to keep the corpus under the professional money management of the trustee, he can cause the trust to continue.


The rules for gifts into trust for minor-grandchildren have the same rules as minor-children, with one exception. That is, the generation-skipping tax may apply to gifts into trust for grandchildren.(14)

Grantor Trust Limitations

In planning to make gifts into trust for minors, an important part of the strategy is to avoid grantor trust status. As noted earlier, there are financial advantages for placing property into trust and giving the trustee the discretion as to whether or not the net income of the trust should be distributed currently or accumulated for later distribution. IRC 674(a) requires a grant or to include the trust's income in his gross income if the grantor or nonadverse party or both has the power to control beneficial enjoyment of the trust. However, IRC 674(b)(7)(B) gives the grantor a substantial amount of flexibility in controlling the ultimate disposition of the trust income without grantor trust status. Specifically, it allows any person to have the power to withhold income while a beneficiary is under the age of 21 years without the imposition of the grantor trust rules. In a similar manner, IRC 674(b)(7)(A) gives the same degree of power when a beneficiary is under any legal disability.


Unlike the language of IRC 2503(c), if income is accumulated while the beneficiary is under age 21, the accumulation does not have to be returned to the income beneficiary by the time he reaches age 21 or his state if not then living. In other words, it gives the grantor the power to shift income away from a minor income beneficiary to a successive income beneficiary, or the remainder beneficiary without causing grantor trust status.

Example. The grantor creates a trust with his daughter, age 8, as the income beneficiary until she is age 21, and then the corpus is to be distributed to the grantor's brother. In addition, the grantor has the power to accumulate income according to his best discretion. Even though trust income can be accumulated before his daughter becomes 21 and become part of the corpus that will eventually be distributed to his brother, the trust will not be considered a grantor trust. However, the grantor will not be allowed a gift tax exclusion, since the accumulated income does not necessarily have to be paid to his daughter by the time she reaches age 21, or if deceased, to her estate.


In drafting the trust instrument, there is a trade-off between the flexibility of controlling trust income, avoiding the grantor trust rules and claiming the annual gift tax exclusion. If it is important for the donor to control the trust income, he may have to forgo claiming the exclusion, depending on the extent of the control over trust income. If both accumulated income and corpus will eventually be transferred to the minor beneficiary upon reaching age 21, the grantor can still have quite a bit of discretion in timing income distributions and still be able to claim the exclusion on the entire gift into trust without grantor trust status.

Relationship to the "Kiddie Tax"

An additional advantage of having a discretionary power over the timing of distributions is to avoid the "Kiddie tax." That is, unearned income in excess of $1,000 received by children under the age of 14 is taxed at their parent's income tax rate.(15) Thus, the grantor may want the trust to accumulate income until the minor beneficiary at least reaches the age of 14. Accordingly, it's possible that the correct timing of distributions could reduce the income tax on distributions by more than half (i.e. 31% for the parent versus 15% for the child).

It should also be noted that distributions to children are a trust deduction. Hence, if the trust is in a higher tax bracket than the child, the overall tax savings can be further enhanced.

Throwback Rule

Subpart D of Subchapter J contains a special rule for accumulated distributions. This rule is known as the throwback rule. The effect of this rule is to prevent a trust from accumulating income in a year where the beneficiary is in a higher tax bracket than the trust; then distributing the accumulated income in a year where the beneficiary is in a lower tax bracket than the trust. In other words, when the income is distributed to the beneficiary, it is taxed at the rate it would have been taxed at had the income been distributed to the beneficiary in the year that it was earned by the trust.

IRC 665(b) specifically excludes the application of the throwback rule to distributions of accumulated income to a beneficiary before they reach age 21. Thus, in planning for a gift into trust for a minor where accumulations are deemed prudent, the throwback rule will not be an impediment as long as accumulations are distributed to a beneficiary before reaching age 21.


A gift into trust for the benefit of a minor can achieve important financial strategies, as well as saving income and gift taxes. It should be kept in mind that the income tax rules and the gift tax rules do not coincide. Nonetheless, a trust instrument, if properly drafted, can provide the grantor and the beneficiary the "best of all worlds."


(1)IRC [section] 2503(b) (2)Reg. 25.2503-3(b) (3) Rev. Rul. 67-384, 1967-2 C.B. 348 (4) Herr v. Com., TC 732 (1961), nonacq., 1962-1 C.B. 5, nonacq., withdrawn acq. substituted, 1968-2 C.B. 2, affd., 303 F. 2d 780 3rd Cir 1962) (5) Com. v. Thebaut, 361 F. 2d 428 (5th Cir. 1966) (6)IRC [section] 2001(b) (7)Reg. 25.2503-4(b)(1) (8)Rev. Rul. 67-270, 1967-2 C.B. 349 (9)Private Ruling 8512048 (10)Faber and Faber v. U.S. 439 F. 2d 1189 (11)Crummey v. Com. 397 F. 2d 82 (oth Cir. 1968) (12)Rev. 25.2503-4(b)(2) (13)Rev. Rul. 74-43, 1974-1 C.B. 285 (14)IRC [section] 2601 (15)IRC [section] 1(g)

Philip R. Fink is the Chairman of the Accounting Department and a professor at the University of Toledo in Toledo, Ohio. He holds a BBA and MBA from the University of Toledo and a JD from Ohio Northern University. He has published in several professional journals.

Suja Kumar is a recent graduate of the Master of Taxation Program at the University of Toledo.
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Author:Fink, Philip R.; Kumar, Suja
Publication:The National Public Accountant
Date:Aug 1, 1992
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