Knowing how taxes work for custodial investment accounts is important.
It can help you save money on taxes, understand your tax liabilities, and plan better for your child's future.
Let's dive in.
- UTMA Taxes Explained
- No UTMA Tax Deferral
- Withdrawals Taxation
- UTMA Tax Benefits
- Tax Rates in 2023
- UTMA Tax Returns
- Who Pays Taxes on UTMA Accounts?
- UTMA Account Taxes - FAQs
UTMA Accounts
Typically the term UTMA Account refers to custodial investment accounts that adults open for children.
UTMA accounts (Uniform Transfer to Minors Act) are a popular investment tool for parents looking to invest for their kids.
These accounts allow an adult, known as the custodian, to purchase securities - such as stocks, bonds, ETFs - on behalf of a minor.
The first $1,250 of a child's unearned income from a UTMA account is tax-free
Control over the account transfers to the child when the minor reaches the age of majority in their state, typically between 18 and 21.
UTMAaccounts are a known tool used by families as a means to transfer generational wealth while minimizing tax payments.
The best UTMA accounts offer an easy to use investing experience, low fees, and investment options that fit your investment knowledge and strategy.
The assets in this account belongs to the child right away, even though an adult manages it.
UTMA Taxes Explained
Let's dive into the world of UTMA accounts and their tax implications.
We'll break it down piece by piece.
When are UTMA Accounts Subject to Taxes?
First off, it's important to note that the assets in a UTMA account are not tax-exempt.
Any income generated from the investments within the account is subject to taxes.
Investments in the account can include stocks, bonds, ETFs, and more.
This includes dividends, interest, and capital gains that occur from selling assets at a profit.
However, since the account is legally owned by the minor, the first $2,500 of profit are taxed at the child's tax rate.
This is the main tax benefit of UTMAs.
This makes the first $1,250 tax free.
No UTMA Tax Deferral
Unlike some financial accounts, such as IRAs or 529 plans, UTMA accounts do not offer the possibility of tax deferral.
The account is funded with after-tax dollars and is subject to regular taxes at the child's rate.
This means that any income generated by the account's assets is taxed in the year it was earned.
There are no provisions to delay or defer these taxes to a later date.
Withdrawals Taxation
The process of withdrawing from a UTMA account doesn't directly incur taxes.
Instead, the taxes are applied to the earnings of the account's assets as they are realized.
There are no additional fees, penalties, or strings attached when looking to withdraw funds.
For example, if you sell stocks from the account at a gain, the profits or capital gains are taxable.
The cash funds in the account you then withdraw have already been taxed.
This provides more flexibility when compared to 529 plans or IRA accounts.
There are no additional fees, penalties, or strings attached when looking to withdraw funds.
UTMA Tax Benefits
UTMA accounts offer attractive tax benefits.
In 2023, the first $1,250 of a child's unearned income from a UTMA account isn't taxed.
In 2024 that amount increases to $1,300.
The next $1,250 is taxed at the child's rate, which is generally lower than the parents'.
This happens because the account is legally owned by the child, not the parent.
UTMA accounts offer attractive tax benefits
This is designed to provide a tax advantage for children who typically have lower income.
Income over $2,500 falls under the "kiddie tax" rules and is taxed at the parent's rate.
Let's take a look at an example of using a UTMA vs a regular brokerage account owned by a parent.
Consider a parent in the 24% tax bracket investing in a regular brokerage account, which generates $800 in dividends and $500 in long-term capital gains.
In this case, the parent would owe $192 in taxes on the dividends ($800 at 24% rate for regular income) and $75 on the capital gains ($500 at 15% tax rate for long term capital gains).
The total is $267 in taxes.
However, if the same investments were held in a UTMA account, the tax situation would be quite different.
The first $1,250 of income from the UTMA account would be untaxed.
If these savings were invested annually at a conservative average return rate of 5% for 18 years, it would amount to roughly $7,370 by the time the child reaches adulthood
The remaining $50 would be taxed at the child's rate, which is usually significantly lower than the parent's rate.
If we assume the child's tax rate is 10%, the tax on this $50 would be just $5.
In this example, the yearly tax savings are significant - the parent would have saved $262 ($267 - $5) each year.
If these savings were invested annually at a conservative average return rate of 5% for 18 years, it would amount to roughly $7,370 by the time the child reaches adulthood.
This underscores the additional benefit of the UTMA tax rules.
They can lower a family's taxes and help save even more money for the kid's future.
They provide a proven way to build generational wealth.
UTMA accounts are a good choice for parents who want to save for their child's future and pay less in taxes.
Tax Rates in 2023 &2024
For the tax year of 2023, dependents have a standard deduction of $1,250 on unearned income.
For 2024 the deduction is increased to $1,300.
That means kids don’t need to pay any taxes on unearned income if it is less than $1,250 for the year 2023.
Kids don’t need to pay any taxes on unearned income if it is less than $1,250 for the year 2023
In 2023, the Kiddie Tax rule kicks in at $2,500.
In 2024, the Kiddie Tax rule kicks in at $2,600.
That means the portion of unearned income above $2,500 a child makes in a custodial brokerage is taxed at the parent's tax rate.
The amount between 1,250 and 2,500 is taxed at the child's rate of 10%.
UTMA Tax Returns
For UTMA accounts, the custodian receives a 1099 form in the name of the minor, since the minor is the account's legal owner.
This form will detail all the income the account generated within the tax year.
This income could include interest, dividends, or capital gains from the sale of assets.
The custodian is responsible for managing the account and dealing with associated tax matters until the minor reaches the age of majority.
However, the income must be reported under the child's social security number as the child legally owns the account.
If the child doesn't fit any of the scenarios, there is no need to report the child's income on any tax return.
There are two scenarios in which a child might need to file a separate tax return:
- The child has earned income (from a job, for example) of more than $13,850 in 2023.
- The child has unearned income (like interest, dividends, or capital gains) of more than $1,250 in 2023.
If the child doesn't fit any of the scenarios, there is no need to report the child's income on any tax return.
For UTMA accounts, unearned income is the primary focus.
If the UTMA account produces more than $1,250 but less than $2,500 of unearned income in 2023, the child's tax can be included on the parent's tax return using IRS Form 8814.
The child's tax can be included on the parent's tax return using IRS Form 8814
This way, the parent can avoid having to file a separate return for the child.
However, there are some caveats to be aware of when including a child’s tax on a parent's return:
- It may subject the parent to an additional tax calculated using Form 8615.
- It may push the parent into a higher estimated tax bracket, potentially increasing their overall tax liability.
If the child's unearned income is above $2,500, then they need to file a separate return under the "kiddie tax" rules.
In this case, the tax is computed on Form 8615.
Who Pays Taxes on UTMA Accounts?
Determining who is responsible for paying taxes on a UTMA account, the parent or the child, can seem complex.
Although the adult manages the account, the tax obligation primarily falls to the child, as the child is the legal owner of the account.
What happens when tax time rolls around?
Let's explore three possible scenarios:
1) Total Unearned Income is Less Than $1,250
The situation where a child's total unearned income, including income from a UTMA account, is less than $1,250 for the tax year of 2023, no taxes are owed.
This income is considered too small to be taxable, making this the most beneficial scenario from a tax perspective.
This income is considered too small to be taxable
Let's illustrate this with an example.
Suppose a parent, earning an average income of $60,000 a year, opens a UTMA account for their child.
Over the course of a year, the UTMA account generates $1,000 in dividends.
If the parent had invested that money in their own brokerage account, the $1,000 would have been added to their taxable income for the year, bringing it to $61,000.
Depending on their tax bracket, they might have had to pay as much as 22% on that additional income, leading to $220 in taxes.
However, in a UTMA account, these dividends are considered the child's income.
Since this income is less than $1,250, it's not taxable at all.
This is where the real tax advantage of a UTMA account comes into play.
2) Child's Tax Return Included on Parent's Return
When the income generated from a UTMA account is more than $1,250 but less than $2,500 in 2023, parents may choose to include their child’s tax on their own return.
In this scenario, parents need to fill out IRS Form 8814 and add it to their return.
In this scenario, parents need to fill out IRS Form 8814 and add it to their return
This simplifies the tax filing process, as it eliminates the need for the child to file a separate tax return.
Any taxes due will be added to the parents' tax payment (or subtracted from the tax return)
3) Child Files a Separate Return
If the UTMA account generates more than $2,500 of unearned income, the child needs to file a separate tax return.
In this case, the first $1,250 of the child's income is tax-free, and the next $1,250 is taxed at the child's rate.
Any income exceeding $2,500 is taxed at the parents' rate, following the "kiddie tax" rules.
When a separate return is necessary, the tax is computed on IRS Form 8615 and attached to the child's return.
Since most parents help handle their child's return, it's likely that the parent will end up paying if there are any taxes due
This form is used to calculate the tax on a child's investment and other unearned income.
Taxes due on the separate return are officially owed by the child.
However, considering that most parents will help handle their child's return, it's likely that the parent will end up paying if there are any taxes due.
UTMA Account Taxes - FAQs
What are the tax rules for UTMA in 2023?
In 2023, the first $1,250 of a child's unearned income from a UTMA account is tax-free.
This is one of the main tax benefits of UTMA accounts.
The next $1,250 is taxed at the child's rate, and income over $2,500 is taxed at the parent's rate.
Do I pay taxes on my child's UTMA account?
Firstly, if the account doesn't have more than 1,250 in unearned income, no taxes are due.
Taxes are only due if the account has more than $1,250 in earnings from dividends, interest, or profit from capital gains.
As a parent or custodian, you're not legally responsible for paying taxes on your child's UTMA account.
The tax obligation lies with the child.
However, considering the difficulty of filing taxes, it's likely that as the parent or custodian you will help handle filing and paying any taxes due.
Does UTMA grow tax deferred?
No, UTMA accounts are not tax-deferred.
Any income generated by the account's assets is subject to tax in the year it was earned.
Do parents report custodial accounts on taxes?
Custodial accounts that make less than the yearly amount for 2023 of $1,250 do not need to be reported.
Accounts that earn more need to be reported.
Parents can choose to add the earnings to their tax return using form 8814, or file a separate tax return for their child.
Who gets a 1099 for a UTMA account?
The 1099 form for a UTMA account is issued in the name of the minor since they are the account's legal owner.
The form is typically sent to the account's adult custodian.
Do I have to report my child's investment income?
A child's investment income, or unearned income, only needs to be reported if it exceeds the standard deduction rate for the year 2023.
In 2023, the standard deduction for unearned income for a dependent is $1,250.
What are the tax advantages of UTMA?
The tax benefits of a UTMA account include the first $1,250 of unearned income being tax-free.
The next $1,250 are taxed at the child's rate, which is usually lower than the parent's.
These tax advantages can add up to hundreds of dollars per year that could be reinvested for even more growth.
Summary
Understanding the ins and outs of UTMA tax rules can help you make an informed decision about using this investment tool for your child's future.
Always remember to consult with a financial advisor or tax professional for personalized advice.
Greatest Gift is the financial gifting platform committed to showing parents how they can save and invest for their children's futures.
