Minors generally aren’t allowed to own securities. But parents can invest money on behalf of their children and put the earnings into an account, or trust, set aside for the child to use. These trusts are known as custodial accounts or UGMA accounts, named for the Uniform Gift to Minors Act that allows children to own securities without an attorney’s oversight. They may also be called UTMA accounts, which comes from the Uniform Transfers to Minors Act that lets children own income-producing property like real estate and fine art. Children and adults can withdraw funds from custodial accounts without tax repercussions, but investment earnings are taxed at the same rates applied to trusts and estates.
Although withdrawals from custodial accounts aren’t taxable, investment earnings exceeding $2,100 are taxed at the rates applied to trusts and estates.
Custodial Account Withdrawal Rules
With custodial accounts, the IRS cares only about the income being generated by the accountholder, not what is done with the funds. As long as earnings remain below $2,100, no taxes are due. However, once those earnings exceed $2,100, it’s time for the child to start filing a tax return. For earnings up to $2,550, taxes on custodial accounts will be 10 percent, increasing to 24 percent for earnings between $2550 and $9,150. For accounts earning $9,150 to $12,500, there will be a 35 percent tax and any earnings over $12,500 will be taxed at 37 percent.
State Income Tax and Other Exceptions
If you live in a state with income tax, you may be required to file a tax form for your child with the state, as well. Also, you may not need to file a separate tax form for your child, as long as all of his income was interests, dividends and mutual funds. You can use Form 8814 to report your child’s interest and dividends. However, you should be aware that you may end up paying more since you’ll be unable to take some of the tax benefits a child can take on a return.
2018 Gift Tax Limits
Anyone can contribute to a custodial account, including parents. But funds shifted into the account could be subject to taxes if they exceed the maximum. In addition to SUTMA withdrawal tax rules, you should also be aware of current gift tax limits. With the Tax Cuts and Jobs Act changes, you can now transfer up to $15,000 each year to your child without tax repercussions. For years 2014 through 2017, you were only allowed $14,000 per year.
If you’re filing a 2017 tax return that includes a custodial brokerage account, you’ll pay interest at your own tax rate, as long as your tax rate is higher than your child’s.
- CUSTODIAL | definition in the Cambridge English Dictionary
- Kiplinger: Big Change Afoot for the "Kiddie Tax" Under the New Tax Law
- Cantrell & Cantrell: Custodial Accounts for Children
- IRS: 2018 Form 8814: Parents’ Election To Report Child’s Interest and Dividends
- Forbes: IRS Announces 2018 Estate And Gift Tax Limits: $11.2 Million
- IRS: 2018 Instructions for Form 8615
- IRS: Frequently Asked Questions on Gift Taxes
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.