A Section 2503c trust allows a parent, grandparent or other donor to make tax-free gifts to a child’s trust and use their annual gift tax exclusion.
Principal and income in the trust can be distributed to the child or used for the child’s benefit as gifts are made. For example, funds in the trust may be used to pay private school tuition or college expenses. Unused or undistributed principal and income can be accumulated in the trust until the child reaches age 21.
During the term of the trust, assets in the trust are managed by the trustee rather than being given directly to the beneficiary who may not use the funds in a responsible manner.
This type of trust is an alternative to Uniform Transfers to Minors Act or UTMA accounts. While only certain types of assets may be transferred to a UTMA account, this type of restriction does not apply to Section 2503c trusts.
When the beneficiary reaches age 21, he or she has the option to continue the trust if the trust document contains provisions allowing it to continue.
Important Facts About Section 2503c Trusts
While a gift to a trust typically does not qualify for the annual gift tax exclusion because it is not a gift of a present interest, gifts to trusts which meet the requirements of Section 2503c of the I.R.C. qualify for the exclusion. These requirements include:
a. The trustee must have discretion to make distributions of income and principal from the trust to the child or for the child’s benefit until the child attains the age of 21;
b. The beneficiary must be permitted to withdraw the entire balance of the trust at age 21; and
c. If the beneficiary is deceased prior to age 21, the entire balance of the trust must be payable to the beneficiary's estate or must pass according to a general power of appointment of the beneficiary.
A Section 2503c trust may contain provisions which provide a narrow window of time for the beneficiary to withdraw the undistributed balance of the trust upon reaching age 21. If the beneficiary does not withdraw the balance within that window, the trust may continue for a specified period of time as set forth in the trust.
If the donor wants the gifted assets to be excluded from his or her gross estate for purposes of estate taxes, the donor cannot serve as trustee of the trust.
Related articles: for trustees and power of appointment trusts.
Other Trusts Used to Make Gifts to Minors
Another type of trust frequently used by donors who wish to make tax free gifts to minors is a Crummey trust. Crummey trusts offer several advantages over Section 2503c Minor’s trusts.
Tax, Estate, and Lifetime Planning for Minors by Carmina Y. D'Aversa. This guide, published by the American Bar Association, features drafting examples for attorneys and forms for creating various estate planning documents. It is one of the best reference books available on federal and state laws on planning for minors.
What is a Section 2503c Trust?
A Section 2503c trust is a type of minor’s trust established for a beneficiary under the age of 21 which allows parents, grandparents, and other donors to make tax-free gifts to the trust up to the annual gift tax exclusion amount and the generation skipping transfer tax exclusion amount. This type of trust is named after the section of the U.S. Internal Revenue Code on which it is based.
Disadvantages of Section 2503c Trusts
1. Property in a Section 2503c minor’s trust cannot be used for another beneficiary if the designated beneficiary does not need the funds or if the donor has a dispute with the beneficiary.
2. The beneficiary has the right to withdraw the entire balance of a Section 2503c minor’s trust at age 21. The donor may not want the beneficiary to have access to a large sum of money at such a young age.
3. A Section 2503c minor’s trust must be for only one beneficiary. Therefore, if the donor wishes to make tax-free gifts to several different children, setting up Section 2503c trusts for each child may be an administrative burden. See also gifts and gifting.
Trust Forms, Templates, and Sample Clauses
One of the best reference guides on minor’s trusts, including Section 2503c trusts and Crummey trusts, is Gift Trusts for Minors Line by Line: A Detailed Look at Gift Trusts for Minors and How to Create Them to Meet Your Needs. This invaluable guide includes sample forms for drafting each type of trust.
Gift Trusts for Minors provides a clear outline of the goals of a minor’s trust, when a minor’s trust should be included in an estate plan, the tax benefits of minor’s trusts, and common misconceptions about these types of trusts. This comprehensive guide to gift trusts for minors also compares and contrasts Crummey trusts and Section 2503c trusts. For those interested in understanding every detail of gift trusts for minors, the guide features a detailed analysis of the clauses typically used in each type of trust. Gift Trusts for Minors is available on Amazon.com.
Tax, Estate, and Lifetime Planning for Minors is a guide to the broader estate planning issues for parents of minor children such as college funds, life insurance, irrevocable life insurance trusts, uniform gifts to minors or UGMA accounts, uniform transfers to minors or UTMA accounts, taxes, and special needs trusts for disabled minor children.
Taxation of Trust Income
A trust pays taxes under its own taxpayer identification number on income accumulated in the trust. Trust income distributed to the child is taxable to the child. Consult your tax professional about the tax consequences of establishing and funding a minor's trust.
For an overview of other types of trusts used in estate planning and gifting, see other types of trusts.
. This invaluable guide includes sample forms for drafting each type of trust.