Custodial Account Tax Rules 2023: A Comprehensive Guide

Custodial account tax rules can be complex, but don't worry, we've got you covered. As of 2023, custodial accounts are subject to the Uniform Transfers to Minors Act (UTMA), which allows minors to own property and assets.

The IRS requires custodial accounts to be reported on the parent's tax return, and the income earned on these accounts is taxed at the parent's tax rate. This is a significant consideration for parents who want to save for their children's future.

In 2023, the first $1,100 of unearned income is exempt from tax, and the next $1,100 is taxed at the child's rate. However, any unearned income above $2,200 is taxed at the parent's rate. This rule applies to all custodial accounts, including UTMAs and 529 plans.

Custodial accounts can provide a valuable way to save for a child's education, but it's essential to understand the tax implications to avoid any unexpected surprises.

There are two types of custodial accounts: UTMA and UGMA. The UTMA is allowed in all states except Vermont and South Carolina, while the UGMA is allowed in all 50 states.

You can set up a UTMA account to hold virtually any kind of asset, including real estate and works of art. However, it is limited to financial assets such as cash and securities.

A UGMA account, on the other hand, has no such restrictions on the types of assets it can hold. In either type of account, you specify the designated custodian, usually the child's parent or guardian.

Initial investments, minimum account balances, and interest rates vary by the company that houses the account.

A custodial account can be a great way to save for a minor child's future, but it's essential to consider the pros and cons before opening one.

One of the advantages of custodial accounts is that they're easy to establish and manage. You can invest in a variety of assets, and there are no income, contribution, or withdrawal limits.

Another perk is that the earnings are taxed at the child's tax rate, up to a certain point, thanks to the kiddie tax. For 2025, the first $1,350 of unearned income is tax-free, and income over $1,350 is subject to the child's tax rate.

However, custodial accounts also have some downsides. For one, they can hurt a child's financial aid prospects because the account is considered an asset owned by the minor.

Additionally, custodial accounts are less tax-advantaged than some comparable accounts, like 529s. You can contribute up to $19,000 for the 2025 tax year without incurring the federal gift tax, but that's still a significant amount to consider.

Here are some key points to keep in mind:

If you're considering setting up a custodial account for your child, it's essential to understand the tax rules and consequences.

Parents can transfer up to $18,000 per child into a custodial account each year, with married couples able to double that amount to $36,000. However, if they transfer more than $18,000, they must file a gift tax return on IRS Form 709, even if no gift tax is due.

The kiddie tax rules apply to custodial accounts, meaning that any unearned income over $2,600 is taxed at the parent's rate, which can be as high as 37%. This can significantly reduce the tax benefits of custodial accounts.

Here are some key tax implications to consider:

If your child's UGMA account didn't earn any income, you're generally not required to file taxes on the account. One exception is if you exceeded your annual gifting limit and need to file a federal gift tax return.

You'll receive a 1099 form for your child's UGMA account if the account earns income, with the type of form depending on the type of income earned. For example, if the account earns interest, you'll receive a Form 1099-INT.

If the account earned less than $1,250 in interest, dividends, and capital gains, no action is legally required, but sharing tax documents can help parents or guardians stay informed.

You don't need to file taxes on a UGMA account if it didn't earn any income. If your child's account had no earnings, you're off the hook.

The IRS typically doesn't require taxes on UGMA accounts with zero income. This is a common scenario, especially for new accounts.

However, there's an exception: if you exceeded the annual gifting limit for that child, you might need to file a federal gift tax return. This is an important consideration for parents who've given more than allowed.

If you're unsure about your gifting limits or tax obligations, it's always a good idea to consult with a tax professional or financial advisor.

You can expect to receive a 1099 form for your child's UGMA account, but only if the unearned income exceeds a certain amount, typically $1,250 in 2023.

The type of 1099 form you receive will depend on the type of income earned in the account, such as interest, dividends, or capital gains.

A Form 1099-INT will be sent if the account earns interest, a Form 1099-DIV will be sent if it earns dividends, and a Form 1099-B will be sent if it earns capital gains.

You may also receive a 1099 Composite that includes a combination of 1099 forms.

Tax documents, including the 1099 form, are typically available by mid-February.

If the account earned less than $1,250 in interest, dividends, and capital gains in 2023, no action is legally required, but sharing tax documents with parents or guardians can still be helpful.

Contributions to UGMA accounts are not tax deductible, but they offer a way to avoid the costly process of setting up a trust and make it easy to give financial gifts to a child.

The IRS considers UGMA contributions as gifts, which may be subject to the federal gift tax. The gift tax threshold is quite generous, with individuals able to gift up to $17,000 to a child in 2023, and couples filing jointly able to gift up to $34,000 to a single child in 2023 without any tax consequences.

You can gift up to $34,000 to each child in 2023 without filing a gift tax return or paying gift taxes, as long as you haven't met the lifetime exclusion amount, which is $12.92 million.

The annual threshold is per child, regardless of how the money is gifted, so it's not just for UGMA accounts.

If you file taxes jointly, you can gift up to $34,000 to each child without needing to file a gift tax return or pay gift taxes, but if you gift more than that, you'll need to file Form 709.

For parents who file individually, the limit is $17,000 per child.

Contributions to UGMA accounts are not tax deductible. This means you won't be able to claim a deduction on your taxes for money you contribute to a UGMA account.

The IRS considers UGMA contributions gifts, which may be subject to the federal gift tax. The gift tax thresholds are quite generous, though, and typically won't be a concern unless you gift an individual child more than $17,000 in a single year.

If you use money from a custodial account for your child's support, you may lose the dependency exemption.

The support test used for the dependency exemption is broad, including items like food, lodging, clothing, and education.

This means that if you pay for these necessities using money from a custodial account, it may be considered support provided by someone other than the parent.

The IRS defines total support as amounts spent on necessities like food, lodging, clothing, education, and medical care.

If the parent provides less than half the child's support, they won't qualify for the dependency exemption.

Capital losses aren't a use-it-or-lose-it scenario, so you can breathe a sigh of relief. You can carry them over from year to year, as long as you complete the correct forms.

The IRS limits capital loss deductions to $3,000, so if you have more losses than that, you can carry over the excess to the next year. This is also true for children who can't use their capital loss deductions due to their income level or other factors.

If your child has both capital gains and losses, the gains will be combined with the losses, and the gains will offset the losses. For example, if your child has $500 in capital gains and $2,500 in capital losses, the net loss would be only -$2,000.

Capital Gains Tax can be a complex topic, but let's break it down simply. If you sell assets for more than their original cost, the difference is considered a capital gain, and it's subject to taxation.

For example, if you have a UGMA account for your child and the assets are sold for a profit, the difference is a capital gain and will be taxed. This is because the unearned income from the account exceeds the reporting threshold of $1,250 for 2023.

The "kiddie tax" rules come into play when your child's unearned income exceeds this threshold, and taxes must be paid accordingly. This means you'll need to report the capital gain and pay taxes on it.

Combining capital losses and gains can be a bit tricky, but it's essential to understand how it works. The IRS allows you to combine capital losses with capital gains, which can help reduce your tax liability.

If you have capital gains, those gains will be combined with your losses, and the gains will offset the loss. This means that if you have $500 in capital gains and $2,500 in capital losses, the net loss would be only -$2,000.

You can carry over any remaining losses to the next year, but you can only deduct up to $3,000 of capital losses per year. This is true for children who can't use their capital loss deductions due to lower incomes or higher incomes with limited loss deductions.

The kiddie tax rules come into play when your child's unearned income exceeds the reporting threshold, which is $1,250 for 2023. This means that if your child's UGMA account assets are sold for more than their original cost, the difference is considered a capital gain, and it's subject to taxation.

If your child's custodial account earns income, you'll need to report it on a tax return. This is because any income from a child's custodial account belongs to the child.

You'll need to file a separate federal income tax return for the child using Form 1040 if their income exceeds certain thresholds. The child will probably owe some tax, and the Kiddie Tax rules may make it higher.

You can choose to report your child's unearned income alongside your own using Form 8814, but be aware that this might result in paying more taxes. The tax rate on your child's income between $1,250 and $2,500 would be 10%, which could be lower than the tax rate you'd pay on your own income.

If you choose to file a separate return for your child, their tax rate could be as low as 0% due to the favorable tax rates for qualified dividends and capital gain distributions.

You'll need to ensure that your child's tax documents are prepared properly, especially if they're over the age of 14. If your child is not old enough to sign, or otherwise unable, you may sign on their behalf.

As the account custodian, you should expect to receive a Form 1099 or a consolidated tax statement for your child's UGMA account. This will depend on the type of income earned in the account and the institution's requirements.

You may receive a 1099 Composite that includes a combination of 1099 forms, such as a 1099-INT for interest, a 1099-DIV for dividends, or a 1099-B for capital gains.

Custodial accounts offer tax advantages compared to noncustodial accounts. However, they also have downsides, including the risk that the account will limit the amount the child can receive in financial aid from a college because it is considered an asset owned by the minor.

Funds withdrawn from a UGMA account 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.

If a child had less than $1,250 in unearned income, they are not required to file a return or pay taxes on that income.

Parents can choose to include income on their own tax return using Form 8814 if the child's gross income was less than $12,500.

If the child's unearned income exceeded $2,500, or if the income wasn't from interest and dividends, Form 8615 is required alongside the child's tax return.

The child will be responsible for paying taxes on any unearned income when they reach the age of majority and gain full control of the account.

Here are the key tax filing requirements for minors with custodial accounts:

Are withdrawals or distributions from UGMA accounts taxable? The IRS doesn't impose withdrawal penalties on UGMA accounts.

Funds withdrawn before the child comes of age still legally belong to the child and must be used for the child's benefit. This means the child's needs come first, and the money should be spent on them.

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.