Gifts to Kids—The Pennsylvania Uniform Transfers to Minors Act
This simple arrangement can avoid expense and court involvement
Minors are “legally incompetent" in that they can’t make enforceable contracts or otherwise engage in financial activities on their own until they reach the age of majority. That's 18 in most states, including Pennsylvania.
A child has full power over her own assets upon attaining that age. Prior to that time, however, an adult must act on her behalf and this arrangement must meet the letter of the law. The Pennsylvania Uniform Transfers to Minors Act (PAUTMA) provides for one such legal arrangement.
When a Minor Receives Money or Property
Minor children can come by property in several ways. Some earn money working. Some receive gifts from grandparents and other family members. Others might receive inheritances, while still others might be injured and be in a position to make financial claims against others.
Money or property can be placed in a minor’s name—that's not a problem. However, the minor can't actually do anything with that money or property. She can't make withdrawals or investment changes. She can't use the money.
A Legal Guardian
Authority to use or manage a minor’s assets can be gained by having a court appoint you as the minor's legal guardian. The court often appoints a parent, but not in every case.
The guardian must make frequent reports to the court and ask for permission to spend principal funds. He usually has limited authority to decide how property should be managed. Guardianship can be an expensive and cumbersome procedure, and it's not always necessary.
An Alternative to Legal Guardianship
The federal Uniform Transfers To Minors Act (UTMA) was drafted and recommended by the National Conference of Commissioners on Uniform State Laws in 1986. Every state except South Carolina has adopted a version of UTMA. South Carolina still uses the Uniform Gifts to Minors Act instead.
As of 2018, Pennsylvania observes PAUTMA, which has replaced the Pennsylvania Uniform Gifts to Minors Act (PUGMA). Under the terms of PAUTMA, a custodian can hold a property for a minor, invest it, and use it for the minor’s benefit without court involvement.
The practical value of PAUTMA is considerable. Parents can set up a stock or mutual fund account under PAUTMA, then grandparents and other family members can make gifts to that account or to the parent for deposit into the account.
A benefactor who is transferring money to the minor must name the custodian of the funds. The asset would be titled: “Jane Doe as Custodian under the Pennsylvania Uniform Transfers to Minors Act for the benefit of minor John Jones," or substantially similar language.
The custodian’s function is similar to that of the trustee of a living trust. The property can be held until the minor attains age 21, three years longer than the age of majority, under Pennsylvania's version of the statute. Until that time, the custodian is the legal title holder and can deal with the asset.
The law is rather liberal as to what expenditures a custodian can make. Pennsylvania statutes cite in 20 Pa.C.A. section 5314:
"...a custodian may deliver or pay to the minor or expend for the minor’s benefit so much of the custodial property as the custodian considers advisable for the use and benefit of the minor, without court order and without regard to: (1) the duty or ability of the custodian personally or of any other person to support the minor; or (2) any other income or property of the minor which may be applicable or available for that purpose."
A custodian is also permitted to reimburse herself for "reasonable expenses" under Pennsylvania law.
Distribution of Inheritances
PAUTMA allows wills, trusts, and beneficiary designations to include a deferral of distribution until the minor reaches age 25. This involves changing the wording of the custodianship language in the will, trust, or beneficiary designation form to specify an age later than the default age. Without this language, distribution will occur under the law at age 21.
Beneficiary designations should include the appointment of a custodian to receive the funds under UTMA whenever insurance policies or retirement plans name minors as beneficiaries or contingent beneficiaries. Otherwise, a court-appointed guardian will be required to receive the funds on the minor’s behalf.
The delayed age distribution date is not available for gifts. These transfers must always be distributed at age 21.
A Custodian's Duty to Report
A custodian is obligated to maintain meticulous records of all transactions and might be called upon by the court to produce them in the event of a dispute. Pennsylvania law also allows the minor to demand a copy of records provided that she's at least 14 years old. Parents and other legal representatives of the minor are also entitled to copies upon request in the event they don't act as Custodian.
Taxes on the Funds
The assets in a PAUTMA account belong to the minor for income tax purposes. The account uses the minor’s Social Security number. All income is reportable on the minor’s own 1040 and on PA-40, the Pennsylvania Income Tax Return.
At one point, the tax rate was tied to the parents' tax bracket when a minor's assets included more than $2,100 of unearned income. This mathematical process is referred to as the "kiddie tax." This changed in 2018 under the Tax Cuts and Jobs Act (TCJA).
The TCJA simplifies the calculation significantly, but it also presents some new considerations so the kiddie tax is still a challenge. The minor's tax rate is now tied to the heftier rate for trusts, although it's less complicated. Consult with a tax professional if the kiddie tax is a concern for your child in 2018 and going forward through 2025 when the TCJA expires if Congress doesn't act to renew it.
Federal estate taxes are not due on funds or property transferred to a minor this way, provided that the transfer is made at least three years before the benefactor's death and the benefactor does not also act as custodian.