EDUCATION: FUNDING TECHNIQUES
Income splitting is simply defined as the shifting of income
to someone who is in a
lower tax bracket than you are. The concept is used primarily to
shift income from high
tax bracket parents to their lower tax bracket children.
Under the Tax Reform Act (TRA) '86 this became more difficult.
The tax code provides for the taxation of a child's (under age
14) net unearned income,
over a certain amount, at his or her parents' higher marginal tax
rate, making the
shifting of unearned income to your children much less desirable.
However, the following
techniques have some merit, particularly for those children who
have attained the age of
fourteen.
Uniform Gift to Minors Act (UGMA) and Uniform
Transfer to Minors Act
(UTMA) -- This is an outright gift to a custodial account for the
benefit of a minor
child. The parent can retain control over the management of the
assets in the account. The
normal rule regarding the annual $10,000 limit for gift tax
exclusion applies.
One possible problem with the UGMA and UTMA is that upon
reaching a certain age, the
child has full discretionary control over the accumulated trust
assets.
Transfer of Appreciating Property -- Would allow
non-income-producing property
with good opportunity for appreciation to be transferred to the
minor before the
attainment of age fourteen. The property would then appreciate up
to or beyond the child's
age of fourteen and could then be sold, allowing the gain to be
taxed in the child's lower
bracket.
Check with your advisors about different applications of this
concept.
Irrevocable Living Trust-- There are many types of
irrevocable living trusts.
For purposes of income splitting, it is a trust created to
receive a one-time gift of cash
or property or ongoing annual gifts of the same for purposes of
shifting the income
produced by the property to the children.
This is probably the most conservative method of shifting
income while maximizing
management control. An irrevocable living trust can also
permanently remove assets from
the grantor's estate, reducing future estate taxes.
Cash Value Life Insurance -- This type of insurance
contract may be considered
one of the best tax-sheltering devices remaining after recent tax
legislation. Parents,
grandparents, or other family members may pay the premiums as
gifts, and the cash value
build-up inside the policy is free of tax during the accumulation
period. When the time
for college arrives, the needed cash may be withdrawn from the
policy (usually on a
tax-free basis), or the cash values can be borrowed at a low
interest rate.
Note that contracts entered into after June 20, 1988 must
satisfy the Technical and
Miscellaneous Reform Act (TAMRA) "7-pay test" or
incur tax treatment on
distributions (including loans) similar to deferred annuities.
