UTMA Taxation for Grandparents

UTMAs have hidden drawbacks.

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A uniform transfer to minors account, or UTMA, is a way that grandparents can put money away for their grandchildren. Sometimes called custodial accounts, UTMA accounts generally stay under the control of an adult custodian until the child reaches the age of majority. Income taxes for earnings in the UTMA account are the responsibility of the minor.

Funding UTMA Accounts

Once you open a UTMA account, you fund it like you would any other investment account. The money you put into the account is on an after-tax basis, so you have already paid taxes on it. While the minor can't directly access the account, once the funds go into the account for the minor's benefit, the gift of funds shouldn't be revoked. As such, the money is considered a gift. If you give more than the annual gift tax exclusion, which is $14,000 as of the publication date, you will have to file a gift tax return. If your lifetime gifts exceed the lifetime exclusion of $5.34 million, you will have to pay gift taxes.

UTMA Account Taxes

Once the money is in the UTMA account, any earnings it generates become taxable to the minor. If dividends or interest are paid by the assets in the account, they are taxed as income. Capital gains from buying and selling stocks or bonds for a profit or capital gains distributions from funds are subject to capital gains taxes.

Kiddie Tax Considerations

A minor's investment income receives special unfavorable tax treatment under the Internal Revenue Service's "kiddie tax" provisions. Under the kiddie tax, children can only claim the standard deduction against their first $1,000 of investment income, as of the publication date. In addition, they only pay taxes at their tax rate on the next $1,000 of investment income. Anything they make from investments over that amount is taxed at their parents' rate.

UTMAs and Financial Aid

If your grandchild might qualify for financial aid, gifting him money in a UTMA account could reduce the amount of aid he receives. When financial aid offices determine how much a student can pay for his education, they assume he can pull out 20 to 25 percent of his savings balance -- including his UTMA account -- to pay for school. If he didn't have the account, he could get more financial aid.