Grand Ways of Making Completed Gifts to Grandchildren

It is not uncommon for grandparents to want to pass along some of their accumulated wealth to their grandchildren. But a recent decision from the 3rd U.S. Circuit Court of Appeals reinforces the importance of having a gifting strategy. In Estate of DeMuth v. Commissioner, the court affirmed the Tax Court’s ruling that certain deathbed gifts made by check were to be includible in the decedent’s gross estate since the checks were not deposited and paid until after the decedent’s death.

When clients write checks to their loved ones, they likely expect them to be treated as outright and completed gifts. As the court has shown, that may not be the case. Some alternative gifting strategies may remove the risk of these gifts being deemed incomplete or giving the donees control over the funds prematurely. Advisers and clients may benefit from discussing the following types of gifting for younger grandchildren:

• Direct tuition or 529 payments
• UTMA accounts
• 2503(c) minor’s trusts
• 2503(b) Crummey trusts
• 2642(c) generation-skipping trusts

Direct Tuition or 529 Payments

Direct tuition payments to schools for another person are not treated as taxable gifts and do not count against the annual gift tax exclusion amounts ($17,000 per person in 2023; $18,000 in 2024). Under the Internal Revenue Code (IRC), public or private K-12 schools, colleges, and universities may qualify. Only tuition expenses (not amounts paid for books, supplies, or room and board) qualify, and only if directly paid to the school. Pennsylvania also offers a tax deduction for 529 education savings plan contributions, depending on the contributor’s gross income. A 529 plan may be used for tuition or other education-related expenses, such as books, school fees, and room and board, and up to $10,000 per student annually may be used for K-12 school tuition expenses. Grandparents have the ability to front-load a 529 plan and pay five years of annual gifts in a single year, allowing more tax-free growth. This strategy does require the filing of a gift tax return and may be subject to a clawback if the donor dies within this period.

UTMA Accounts

Grandparents have an option to fund accounts under the Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA). The grandparents could hold investment and distribution control, but the funds must be distributed to the grandchild once he or she is no longer a minor. These accounts offer administrative convenience with a broad range of investment options and unfettered distribution. However, they may be includible in the custodian’s taxable estate while the grandchild is a minor.

2503(c) Minor’s Trusts

Grandparents may also establish and fund an irrevocable 2503(c) minor’s trust, where they, as the trustees, have investment and distribution control over the assets for the minor’s benefit. Although these assets are distributable to the grandchild upon attaining age 21, the trust may be drafted to grant a withdrawal power to the grandchild for a limited period of time (typically between 30 and 60 days) after attaining such age. If not withdrawn, the assets may remain in trust for up to his or her lifetime. Timely and transparent conversations with the grandchild about the benefits of holding in further trust could be beneficial.

2503(b) Crummey Trusts

A 2503(b) Crummey trust can be used for a large class of beneficiaries (such as all of the grandchildren) and, unlike a 2503(c) minor’s trust and UTMA account, there is no set termination date. Distributions may also be made for any purpose. However, this trust will not qualify for the annual generation-skipping transfer (GST) tax exclusion if it has multiple beneficiaries or if the trust assets would not be includible in a beneficiary’s estate. These trusts may be most valuable when the grandparents expect future appreciation of the trust assets and nonimmediate distribution needs.

2642(c) GST Trust

A 2642(c) GST trust does not require the grandchild to gain the power of withdrawal upon attaining age 21. Unlike a 2503(b) Crummey trust, a grandparent must establish a separate 2642(c) GST trust for each grandchild, and any trust property remaining at the grandchild’s death must be included in his or her gross estate. The grandchild must also be given a Crummey withdrawal right. These trusts may be held for a grandchild’s lifetime, and distributions may be made for any purpose. Contributions may qualify for the annual GST exclusion if the trust terminates at some later date or the assets are includible in the grandchild’s gross estate at their death. Otherwise, the grandparent must allocate their remaining GST exemption for any trust contributions.

Many clients may choose to incorporate gifting to grandchildren and other loved ones prior to the anticipated sunset of current estate tax exemption amounts in 2026. By reviewing options for making a completed gift, clients and advisers can ensure that such gifts are not later deemed to be includible in the client’s gross estate and that families can enjoy the protection and future appreciation of these gifts. 

Brian M. Balduzzi, JD, LLM (Taxation), CFP, is an attorney with Faegre Drinker Biddle & Reath LLP in Philadelphia and is a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at brian.balduzzi@faegredrinker.com.