A custodial Universal Transfer to Minors Account, or UTMA, can be used to start a savings program for a child. The UTMA structure gives a custodian control over the investments and distributions of an account until the child turns 18 and legally becomes the owner of the account assets. While a UTMA also carries some tax benefits, those benefits are limited.
Contributions to a UTMA can be made by anyone, at any time, in any amount. However, contributions are not tax-deductible. Additionally, there is a limit as to how much you can put into a UTMA in any given year without triggering gift taxes. As of 2015, this limit was $14,000 per person. Amounts deposited in a UTMA above this per-person limit, which is indexed for inflation and subject to change annually, could be taxed at a rate as high as 40 percent. Gift tax is payable by the donor, not the recipient, and requires the filing of a federal gift tax return.
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One of the main benefits of a UTMA is that part of the income generated in the account is tax-free, and some of it is only taxed at the child's rate. Since most children are in a lower tax bracket than their parents, earning money in a UTMA can result in some tax savings. However, the amount of income you can shelter from higher taxes comes with some restrictions. For 2015, the first $1,050 of a child's income in a UTMA is tax-free. The amount from $1,050 to $2,100 is taxed at the child's rate. Any income earned above those amounts is taxable at the parents' top tax rate.
You'll have to file a tax return in the child's name to report earnings in a UTMA. Taxes can be calculated using Form 8816, "Tax for Certain Children Who Have Unearned Income." You can elect to report the child's income on your own tax return instead, but you'll lose the benefit of taxation at the child's rate.
The tax structure applicable to UTMAs is known as the "kiddie tax." However, the kiddie tax extends all the way until a child turns 19, or 24 for children who are full-time students whose earned income doesn't exceed half of their annual expenses. The kiddie tax only applies to unearned income, such as money earned from investments. Earned income is taxed at the child's rate, regardless of their age or the amount they earn.