UTMA to pay for private pre-school with appreciated stocks?

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UTMA to pay for private pre-school with appreciated stocks?

Post by kevinpet » Sun Oct 14, 2012 10:21 pm

I have two young sons, the older is in pre-school that runs around $600/month and I'm contributing $2k/year each to Coverdell accounts. My wife does not work so we cannot use a FSA to pay this as childcare expenses. I'm considering opening a UTMA account to take advantage of selling appreciated stock at his tax rate and using the proceeds to pay for preschool and fund the ESA. I'm looking at one investment bought at about $3k now worth $5k, which would be enough to let him pay for school for the rest of the year while saving me about $450 in taxes (California).

In CA a UTMA does not need to release to child's control until 25 if you set it up that way. Also, I'm not expecting to contribute a huge amount of money so the "18 year old blow it on a Porsche" isn't a factor. I'm aware that a UTMA account is an irrevocable gift.

Over the next few years, even if I'm able to gift stock that's gone up 30% instead of directly contributing to the kids ESAs, it seems like I could save a couple hundred dollars a year. If I anticipate more expenses I can justify as being for the child's benefit like pre-school or a semester of studying abroad, this seems like it could save me thousands in taxes.

My questions:

1. Am I misunderstanding anything about UTMAs? Is there something that makes this not possible?

2. Is sending capital gains through a UTMA and immediately spending it for the kids benefit like this a big red flag that's going to get me audited?

3. How do I actually spend money from a UTMA for the child's benefit? Pay it myself then reimburse from UTMA?

Bonus question:

My investments are at Wells Fargo in a PMA-linked account as are my kids ESAs. Is Wells Fargo any good about handling these kinds of things? Is it relatively painless to transfer securities into the UTMA? Am I going to get destroyed by fees on every asset transfer?

Bob's not my name
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Re: UTMA to pay for private pre-school with appreciated stoc

Post by Bob's not my name » Mon Oct 15, 2012 3:32 am

I've done this. Since you're the trustee, you manage the transactions. Keep the school bills, payments, and UTMA deposit/withdrawal records.

Provided you keep the annual realized LTCG under the $1,900 kiddie tax threshold, they will be taxed 0% federal (at least for 2012) vs. at your rate. Your rate might be 15% in 2012, or it might be higher if you're in a phaseout like the child tax credit phaseout. I did not look up how California taxes dependents, but I expect your $450 number assumes the child will also pay 0% state tax.

In the years I did this I was in the AOTC and MWP phaseouts, so my federal rate on LTCG was 29.5%. I was also at the edge of the spousal TIRA phaseout, so avoiding any additional income was very valuable.

My accounts and the UTMAs were both at Vanguard. To transfer between accounts I had to get a signature medallion, which was annoying, but overall the paperwork was easily worth the savings -- almost $1,000/year, since I was doing it for two kids. Of course you can make one transfer and then sell in increments. Right now you could transfer assets with $3,800 of unrealized gains and sell half immediately and half in January.

Remember that realizing the gains and spending the money are separable events. Also remember to take dividend and capital gains distributions into account when you're calculating how much LTCG can be accommodated under the kiddie tax threshold -- for example, if you transferred X shares of TSM and sold 0.5X shares immediately, remember that the remaining 0.5X shares will have dividend and capital gains distributions in December.

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Re: UTMA to pay for private pre-school with appreciated stoc

Post by sscritic » Mon Oct 15, 2012 7:46 am

Just looked at CA. If the child has capital gains other than from a mutual fund, the standard deduction is the larger of $950 and earned income; use Form 540 (if only from a mutual fund, use Form 540A and your standard deduction is the larger of $950 and earned income plus $300, just like the feds).

With $1900 of cap gains, your taxable income will be $950 and the tax is $9 from the tax table. CA does not offer a lower rate on cap gains like the feds; there is no "0%" bracket for the child.

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Re: UTMA to pay for private pre-school with appreciated stoc

Post by Wagnerjb » Mon Oct 15, 2012 8:25 am

Bob's not my name wrote:I've done this. Since you're the trustee, you manage the transactions. Keep the school bills, payments, and UTMA deposit/withdrawal records.
I have done this too, and my experiences mirror those of NotBob. I transfered funds from the UTMA into my personal account, and spent the money from there. Just keep receipts for what you spent on the child. I don't think this should increase your audit risk. I used UGMA accounts for almost 20 years, and was never audited.

Expect a few minor hassles in dealing with the UGMA account. Occasionally, you will find red tape at your financial institution in trying to move money around. As was the case for NotBob, I had to get a Medallion Signature for Vanguard a few times....which is essentially the same as a notary signing the transfer documents.

If you want to get the full benefit of the entire $1900 kiddie tax threshold, consider contributing more funds to the UTMA - enough to generate a steady and predictable income. When your child is in high school, you should be able to spend those funds on him/her and use up the UTMA before they turn 18. Things like summer camp, the child's first car, band, ballet lessons, gymnastics, football, music lessons, vacations, trips to see grandma, etc.

Best wishes.

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Re: UTMA to pay for private pre-school with appreciated stoc

Post by gtaylor » Mon Oct 15, 2012 12:21 pm

One gotcha I don't see mentioned here is that UTMA accounts are child's assets on FAFSA. The expected tuition contribution formula counts child's assets at 20% per year, IIRC, versus 5% or so for liquid parent assets. So in some cases it would be most tax-plus-FAFSA efficient to spend them down before about year 3 of high school, which is a little earlier than the age 18 suggested by Wagnerjb.

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