Custodian accounts opened under the terms of the Uniform Gifts to Minors Act or the Uniform Transfers to Minors Act are taxable on your child's income taxes. However, if your child earns too much income in these or other investment accounts, she can be taxed at your, likely higher, income tax rate. If you prefer, though, you can opt to pay tax on them through your own tax return.
UGMA or UTMA
In many states, UGMA accounts are really UTMA accounts. The two account types are similar, although the UTMA laws allow the account to own additional types of investment. In either case, the account is designed to be owned by the child but managed by a custodian. When the child reaches the age of majority, she automatically gets ownership of the account.
Your Child's Taxes
If your child doesn't work, the first $950 of income that she earns in a UGMA account is tax-free, since it is covered by the child's standard deduction for investment income. Anything over $950 but below $1,900 is taxed at your child's tax rate. When your child's earnings in her UGMA or any other investment account go over $1,900, they will almost always be taxed at your income tax rate. If your child has work income, her standard deduction for investments gets reduced to $350.
If you prefer, you can pay the taxes on your child's UGMA/UTMA investment income on your tax return as long as you meet the Internal Revenue Service rules. Your child must be under 19, or under 24 if a full-time student, only have income from interest and dividends, and have a gross income of $9,500 or less. While this may leave you paying more taxes, it will save the inconvenience of filing separate returns.
Putting your child's money in a UGMA/UTMA account could have ramifications if you are using it to pay for college. Contributions to UGMA/UTMA accounts are taxable, while contributions to 529 savings plans aren't. Earnings in 529 plans are tax-free as long as they're spent on educational expenses, while UGMA earnings are taxed once your child uses up her standard deduction. A UGMA account can also limit your child's ability to receive financial aid, while a 529 plan is counted as your asset and has less impact on financial aid eligibility.
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