Gifts to children can be tax free through the use of a 2503(c) trust (also called a “children’s trust”).  These trusts are named after the Internal Revenue Code section that makes these gifts free from taxation.

A gift to any person is subject to federal gift taxation unless an exemption or credit applies.  The most common exemption is the annual exemption, which permits each person to give up to $13,000 (adjusted for inflation) to any number of people without incurring gift taxes.  In addition, each person has a lifetime credit against gift taxes, which allows for tax-free gifts totaling up to $1 million.  But often people want to make a gift to a person valued at more than $13,000.  And using the lifetime gift tax credit results in a dollar-for-dollar reduction in the giver’s credit against estate taxes at death.  This makes the ability to make tax-free gifts–of unlimited value–to children valuable indeed.

To qualify for tax-free treatment under Code Section 2503(c), the gift must be made to an irrevocable trust for the benefit of a person under the age of 21 years.  Until the child turns 21, the trust assets and income can be used for the child’s benefit, in the discretion of the trustees.  If the child dies prior to turning 21, the trust assets must be distributed to the child’s estate or to the beneficiaries named in the child’s will, if any.  Upon turning 21, the child must be given the opportunity to withdraw all of the trust assets from the trust.  The child must be given notice of his or her withdrawal right. 

Understandably, the right of a 21-year-old to have free access to valuable trust assets is a drawback to the use of 2503(c) trusts.  However, in most cases, the child can be convinced that it is not in his or her best interest to withdraw the trust funds (for example, if it would be the last gifts the child would see).  If the child elects not to withdrawal the trusts funds, the funds can remain in the 2503(c) trust, available for the child’s use and generally shielded from his or her creditors.