If you plan to open an UGMA (Uniform Gift to Minors Act) account this year or are preparing to file taxes for the first-time as a custodian, you may have a few questions. While federal and state tax laws can be confusing and complicated, most parents can rest assured that managing taxes for a child’s custodial account will be fairly painless. In general, the amount and source of your child’s income will determine whether you need to report their earnings or pay taxes on their behalf. This guide will focus on investment income from your child’s custodial UGMA account.
How are UGMA accounts taxed?
UGMA accounts are subject to taxes just like any other investment account. This means that if your child earns interest, dividends, or capital gains from the money in the account, you may need to file a tax return to report that income on their behalf. Whether you are required to file or pay will depend on the total amount of "earned" and "unearned" income your child has.
Earned vs. unearned income for a minor
When it comes to your child, there are two types of income to consider:
- Earned income is income that your child earns from working. It also includes funds received from taxable scholarships or other grants. Earned income should never be counted or reported as part of a parent or guardian’s income.
- Unearned income typically comes from a child’s investments, and it can include taxable interest, dividends, capital gains, trust distributions, and more. Depending on the situation and your personal preferences, unearned income can be claimed on your tax return or in a separate return for your child.
If your child has multiple sources of income, it is recommended that you speak with a financial advisor or tax professional for the best approach to your specific situation.
UGMA tax rates for 2022
Each year, the IRS has a defined set of thresholds for taxing a minor’s unearned income. These rules apply to children who are under 19, as well as full-time students who are 24 years old or younger.
Assuming your child has no earned income, the following rates apply for the 2022 tax year:
- The first $1,150 of a child’s unearned income is not taxed
- The next $1,150 is taxed at the child’s rate, which is usually lower than the parent’s
- Any amount over $2,300 is taxed at the parent’s marginal tax rate
This effectively means that if your child’s UGMA account provided less than $1,150 in unearned income in 2022—and your child did not have any other sources of income—then you won’t need to file or pay taxes on their behalf.
For the 2023 tax year, the thresholds increase to $1,250 and $2,500. The thresholds are also higher if your child is legally blind.
Are UGMA accounts tax deferred?
No, UGMA accounts are not tax-deferred. This means that unearned income from the account is eligible for taxation each year. While you may not always need to file or pay taxes on unearned income, it is important to ensure that your child’s earnings have not exceeded the reporting thresholds set by the IRS each year.
Are UGMA contributions tax deductible?
No, contributions to UGMA accounts are not tax deductible. While there are currently no tax credits or deductions related to UGMA accounts, one of their biggest advantages is that they help parents to avoid the often costly process of setting up a trust, and they make it easy for any adult to give financial gifts to a child.
Since UGMA contributions are considered gifts by the IRS, they may be subject to the federal gift tax. That said, the gift tax thresholds are very generous and typically not a cause for concern unless you intend to gift an individual child more than $17,000 in 2023, or you gifted $16,000 to a child in 2022. This means that couples who file taxes jointly can gift up to $34,000 to a single child in 2023 without any tax consequences.
Do you pay taxes on capital gains for UGMA accounts?
If the assets held in your child’s UGMA account are sold for more than their original cost, the difference is considered a capital gain, and it is subject to taxation. When your child’s unearned income exceeds the reporting threshold ($1,150 for 2022), then taxes must be paid according to the “kiddie tax” rules.
What is the kiddie tax?
The “kiddie tax” is a tax reform measure passed in the 1980’s that made it more difficult for parents to avoid paying taxes on investment income. Rather than allowing 100% of a child’s unearned income to be taxed at a lower rate, the kiddie tax sets an upper limit on the amount of unearned income that is taxable at the child’s tax rate. Anything exceeding this threshold is taxed at the parent’s marginal tax rate. For 2022, the parent’s tax rate kicks in for any unearned income exceeding $2,300.
Do I need to file taxes for an UGMA account without earnings?
If your child’s UGMA account did not earn any income, such as interest, dividends or capital gains, you generally are not required to file taxes on the account. One exception would be if you exceeded your annual gifting limit for that child, and as a result needed to file a federal gift tax return.
How much can a parent gift to a child tax-free?
While there is technically no maximum that you can contribute to an UGMA account, gift amounts that exceed the annual thresholds set by the IRS are counted toward a parent’s lifetime gift-tax exclusion limit. As of 2023, the federal lifetime limit is $12.92 million.
This means that in 2023, parents who file taxes jointly can gift up to $34,000 to each of their children without needing to file a gift tax return or pay gift taxes, as long as they haven’t met the lifetime exclusion amount. If the amount contributed to a child exceeds the annual threshold, then a gift tax return, Form 709, must be filed.
For parents who file individually the limit is $17,000. It is important to note that the threshold is the total gift amount per child regardless of how the money is gifted (UGMA account or other means.)
Who pays taxes on custodial accounts for minors?
As the legal owner of the custodial account, your child is technically on the hook to file a tax return and pay any taxes or penalties owed on unearned income. That said, if your child is still a minor, there are a few considerations to keep in mind:
- If a child had less than $1,150 in unearned income in 2022, they are not required to file a return or pay taxes on that income.
- If a child’s only income was from interest and dividends (including capital gains distributions) and their gross income was less than $11,500 in 2022, parents can choose to include that income on their own tax return using Form 8814 or file a separate tax return on behalf of the child.
- If the child’s unearned income exceeded $2,300 in 2022, or the child had unearned income that wasn’t from interest and dividends, Form 8615 is required alongside the child’s Form 1040 or 1040-NR.
When your child reaches the age of majority and gains full control of the account, they will be responsible for paying taxes on any unearned income.
Parents' election to report child's interest and dividends
If you prefer the convenience of filing a single tax return, you can choose to report your child’s unearned income alongside your own using Form 8814. To elect this option, your child must be under 19 or be a full-time student under 24. Multiple Form 8814 documents may be used if you have more than one child, but you are not required to choose this option for all of your children. Some additional conditions also apply.
While it may seem easier to do, if you choose to go this route, you could end up paying more taxes. This is because the tax rate on your child's income between $1,150 and $2,300 would be 10%. If you were to file a separate return for your child, your tax rate could be as low as 0% due to the favorable tax rates for qualified dividends and capital gain distributions. You should also keep in mind that the 10% tax rate applies to your kids’ combined income, so any amount in excess of $2,300 would be taxed at your maximum income tax rate. Finally, by increasing your adjusted gross income, you could lose or reduce your eligibility for certain tax credits and deductions including the child tax credit or deductions for IRA contributions.
There are more considerations for parents who are not filing jointly. In that scenario, it is recommended that you consult a tax professional.
Filing a separate tax return for your child
If your child must report their unearned income, it is your responsibility to ensure that their tax documents are prepared properly. If your child is over the age of 14, they generally must sign their own return. If your child is not old enough to sign, or otherwise unable, you may sign on their behalf. In general, any parent or guardian who signs a child’s tax return can engage with the IRS on behalf of the child, as needed. The authority of a non-signing parent is more limited.
Will I receive a 1099 form for my child’s UGMA account?
Yes, as the account custodian, you should expect to receive a Form 1099 or a consolidated tax statement for your child's UGMA account. Depending on the institution, you may only receive a 1099 form if your unearned income exceeds a certain amount. The specific form you receive will depend on the type of income earned in the account. For example, if the account earns interest, you will receive a Form 1099-INT; if it earns dividends, you will receive a Form 1099-DIV; and if it earns capital gains, you will receive a Form 1099-B. You may also receive a 1099 Composite that includes a combination of 1099 forms. Tax documents are typically available by mid-February. Use these instructions to find the tax statements for your EarlyBird account.
What if I am not the child’s parent or guardian?
Generally speaking, if the account earned less than $1,150 in interest, dividends, and capital gains in 2022, no action is legally required. However, if the child’s unearned income exceeded that amount, or if you simply want to keep their parents or guardians in the loop, sharing tax documents can help them stay informed. If taxes must be filed, you may even prepare the necessary tax forms on the child’s behalf, as long as a parent/legal guardian gives you permission and the child or parent is the actual signer of the return.
Are withdrawals or distributions from UGMA accounts taxable?
The IRS does not impose withdrawal penalties on UGMA accounts, however funds that are withdrawn before the child comes of age still legally belong to the child and must be used for the child’s benefit. Outside of taxes on any unearned income and capital gains from the sale of assets, there are usually no additional taxes applied when funds are distributed or when an account is closed.
Talk to a tax professional
Tax thresholds change each year, and the rules can become complicated for certain situations. For information that is specific to your child’s account and your financial goals, be sure to seek guidance from a fiduciary financial advisor, a certified public accountant, or another tax professional.
This page contains general information and does not contain financial advice. All investments involve risk. Any hypothetical performance shown is for illustrative purposes only. Actual investment performance may be different for many reasons, including, but not limited to, market fluctuations, time horizon, taxes, and fees. Please consult a qualified financial advisor and/or tax professional for investment guidance.