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This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal adviser.

"I want to establish a College Fund for my new child/grandchild. What should I do?"

There are really two questions: first, an appropriate investment vehicle, and second, an appropriate investment. This Brochure will address only the first issue; the second issue is outside of the scope of our expertise.

Tax Free Gifts

Each person may give free of gift taxation $10,000 per calendar year to each of an unlimited number of recipients. A married couple may give $20,000 to each recipient.

While the receipt of a gift is not taxable income to the recipient, it is not income tax deductible to the donor.

Gifts have several tax advantages. First, the future income from the gifted asset is taxable to the donee. Second, the gifted asset (and any increase in value) avoids taxation as part of the donor's taxable estate at his later death.

For example, Grandpa is a widower, and a savvy stock investor. He bought XYZ at $5. When it was worth $100, he gave $10,000 worth (100 shares) to each of his 10 descendants.

The amount of this tax free gift is its value on the date of the gift, not the donor's tax basis.

After the gift, the donees pay tax on the dividends. If they sell the stock, they pay tax on the profit.

For lifetime gifts, the donee `carries over' the donor's tax basis.

When a donee sells the stock, he pays tax on all profit over Grandpa's $5 tax basis, including the $95 built in profit on the day the gift was made. This presents a tax planning opportunity for Grandpa to allow the stock to be sold, and have the donee pay the tax at his lower tax rate.

However, if a subsequent sale is pre-arranged the income will be taxed to the donor. [If real estate is being gifted, it should not be `in contract,' or even listed for sale, until after the gift is made.]

Years later, at Grandpa's death, the initial $10,000 gifts are worth $50,000. None of the gifts are part of Grandpa's taxable estate. If he had not made these 10 gifts, Grandpa's taxable estate would have been $500,000 larger.

A downside of lifetime gifting of property is that the donee's basis is carried over from the donor. Even at the donor's later death there is no step-up in basis (which would have occurred with an inheritance rather than a lifetime gift).

[The basis of inherited assets is `stepped-up' to the date of death fair market value. If Grandpa kept the stock and later left it to his descendants, they could later sell the stock and pay tax only on the post-death profit. For lifetime gifts, there is never a step-up in basis.]

Aggressive gifting may be very appropriate for individuals whose net worth will exceed the tax free amount (currently $600,000) at their death.

There is no limit to the number of people to whom a donor may give $10,000 each year.

In addition to the annual $10,000 tax free gift rule, an additional amount may be gifted by direct payment of tuition and medical expenses.

Gifts of Real Property

One situation we frequently encounter is families who want to make gifts but do not have liquidity. Instead of giving stocks or checks, consider giving $10,000 shares of real estate. This passes wealth tax free without impairing your liquidity, or even worse, giving your children something they can spend, waste, or lose in a divorce. This works very well in a Family Limited Partnership.


There are special concerns and several methods of making gifts to minors.

The most simple method of making gifts to minors is UTMA: the California Uniform Transfers to Minors Act, under which a Custodian is named to hold, invest, and spend assets for a minor. The Custodianship may last until the minor reaches age 21, if the donor specifies that age on establishing the account. If no age is specified, the minor becomes the outright owner of the gift when he reaches age 18. Then, if he wants to buy a Corvette with the college fund, there is no way to stop him.

[Under California UTMA, lifetime gifts to minors require distribution no later than age 21; gifts effective at death (by Will) may specify that Custodianship will last until age 25.]

UTMA is the most simple method of gifting to minors. The gift is out of the child's control, until he reaches age 21, when any remaining funds must be given to the child. Hopefully, it is all spent (by the Custodian) for the child's education by the time the child reaches age 21 when he gets any remaining assets.

With an UTMA account there is no cost of formation and the only tax returns required are the regular 1040 for the child.

[If the child is under 14, and his income is over certain limits the child must pay tax at his parents' rate. In 1995, the limit is $1,300; this is adjusted annually for inflation]

For the donor's death tax there is a risk: if the donor is the Custodian, the gift does NOT escape taxation as part of the donor's taxable estate. Therefore, some person other than the donor should be Custodian.

Trust Fund

A better, but more expensive, method is to establish a formal Trust for each child. This allows assets to be held for the child, even after he has reached age 21. This protects against the child ever foolishly spending the money without the consent of the Trustee.

A person other than the donor should be appointed Trustee (Manager), with full investment authority and full spending power, to spend for the health, education, and support of the child. When the child reaches whatever age is specified in the Trust document, the child gets the assets without any further supervision.

A Trust is more cumbersome than an UTMA gift, although it allows the assets to be managed for the child for a longer time period. Annual Tax Returns are required and stock brokers or bankers will want to see copies of the Trust.

Like an UTMA gift, a Trust is irrevocable - once given, it cannot be taken back, regardless of need or changed circumstances.

Our favorite method of making gifts to minors remains the Family Partnership. Gifts can be made but the donor keeps control; the child cannot spend it; wealth is transferred tax free.


It is a major mistake to place a minor's name on a Deed to real estate. As the minor cannot sign, a Probate Guardianship is necessary to sell or refinance.

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