Giving away a custodial account and what to do about taxes

Karin Price Mueller/The Star-Ledger  writes: Q. My mother purchased mutual funds for my two nieces when they were born. They are in my name as Custodian FBO for my nieces. Originally my mother wanted to give the accounts to them when they graduated high school, but now she wants to wait until they graduate college. The girls don’t know about the accounts. The accounts have had capital gains each year and no taxes have been requested or paid. — No name please.

A. You’re going to need to talk to your tax adviser about this one.

But first, your mom probably doesn’t have much say in when your nieces get these assets.

"Since the accounts state FBO and were opened when the nieces were born, I am assuming that they are covered under the Uniform Gift to Minors Act (UGMA) or newer Uniform Transfers to Minors Act (UTMA)," said Mark Ukrainskyj of Covenant Asset Management in Chester.

He said you should check the statements to make sure you understand how the accounts are listed.

If they are UTMAs or UGMAs, the assets in the accounts become the property of the minors once they are either gifted or transferred into the account, he said.

"The custodian, in this case the writer, manages the assets, but they belong to the minor," he said. "Power over the assets transfers over to the minor when they reach adulthood. The nieces can then do with the assets as they wish."

The age of adulthood varies between 18 and 21 depending upon each state. Ukrainskyj said the good news for your mom is that most states now use 21 and some states even allow for the transfer to be delayed until age 25 if so specified at the creation of the account.

In New Jersey, he said, the age of adulthood is 21, however, the custodian can elect to have the UTMA dissolve earlier when the minor turns 18 if that is specified when the asset transfer is originally made.

The tax issue is something you will have to investigate.

The earnings on the account belong to your nieces, and they are responsible for paying the tax on this income in the eyes of the Internal Revenue Service, said Alan Meckler, a certified financial planner with Cornerstone Financial Group in Succasunna.

"The investment gains in an UTMA will be taxed according to the kiddie tax rules," he said. "The first $1,000 of annual earnings in the account are tax-free. The next $1,000 of earnings are taxed at the child’s tax rate of 10 percent. All other investment gains will be taxed at the parent’s tax rate."

When the account terminates, the custodian — you — will transfer the property to your nieces, who can use it in any way they choose.
Meckler said you will need to speak to your accountant as far as filing income tax returns and paying taxes if they exceeded the kiddie tax rules.
"They can give you guidance as far as penalties and interest payments are concerned," he said. "There would never have been a request from the IRS for your nieces to file a tax return. That is something that they are responsible for doing."
These accounts should have kicked off 1099 Forms to help determine the tax liability.