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2503(c) Minor's Trust

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A section 2503(c) Minor's Trust is a separate legal entity (a trust) established to hold gifts in trust for a child until the child reaches age 21. The trust is named after the section of the Internal Revenue Code upon which it is based.

Normally, for a gift to qualify for the annual $13,000 gift tax exclusion, it must be a gift of a present interest. This means the recipient must be able to use the gift immediately. A gift of a future interest in some property (e.g., the right to the money when the child turns 21) would not normally qualify, except for section 2503(c) of the Internal Revenue Code. Section 2503(c) sets out the conditions under which a gift of a future interest to a minor qualifies for the gift tax exclusion.

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The requirements for such a trust are as follows:

  • The property and income in the trust may be expended by or for the benefit of the child before the child reaches age 21. This means income can accumulate in the trust or be distributed to the child. It also means the trustee has the authority to make distributions on behalf of the child or distributions directly to the child until the child reaches age 21.
  • If the child dies before reaching age 21, the trust will be included in the child's estate.
  • All undistributed property and income must be distributed to the child on his 21st birthday.
  • Gifts to the trust are irrevocable.

The trustee can spend the trust's funds to pay college expenses for the child.

Often, the trust document establishing a 2503(c) Minor's Trust will restrict the right to the money to the 30, 60 or 90 days after the child turns 21. If the child chooses to not exercise their right to the money during this window, the money can remain in the trust until a date specified in the trust document. This variation on a 2503(c) Minor's Trust is sometimes referred to as a Window Trust.

After the child turns 21, gifts to a 2503(c) trust no longer qualify for the gift tax exclusion. It is common for 2503(c) Minor's Trusts and Crummey Trusts to be combined into a hybrid trust that acts as a 2503(c) trust until age 21 and then converts to a Crummey Trust. This allows annual gifts to the trust to continue to qualify for the gift tax exclusion after the child reaches age 21.

Income from the trust is taxed at trust rates unless distributed to the child, in which case it is taxed at the child's rates.

If the beneficiary elects to leave the property in the trust after his 21st birthday, he becomes the owner of the trust for income tax purposes. The beneficiary must then pay income tax on the trust's earnings even though it is not distributed to him.

The disadvantages of these trusts are as follows:

  • High setup and administration costs, due to the involvement of an attorney (e.g., drafting of the trust document).
  • Taxed at trust rates, which are similar to those for individuals, but with compressed brackets. The trust has its own taxpayer identification number and files its own income tax returns each year (IRS Form 1041).
  • The trust is treated as an asset of the child for financial aid purposes (high impact).
  • If the donor acts as a trustee, the trust will be included in the donor's gross taxable estate. It is best if the trustee is someone other than the donor or the donor's spouse.

If income from the trust pays life insurance premiums on a policy where the donor or the donor's spouse are the insured or uses the income to pay for parental obligations or other legal obligations of the donor, the donor will have to pay taxes on the income. Likewise, if the donor reserves the right to receive income from the trust, the donor must pay taxes on the income.

Generally speaking, most parents will find that using the Uniform Gift/Transfer to Minor's Act meets their needs just as well as a 2503(c) Minor's Trust or a Crummey Trust. Note that all three types of trusts are treated as the child's asset for financial aid purposes, and so have a high impact on need-based financial aid eligibility. In most cases the parents would be better off establishing section 529 plans for their children.

 

 
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