TAX-CUTTING WAYS TO GIVE TO YOUR KIDS Transferring assets to your children or grandchildren has become one of life's familiar passages. And while you are at it, there are big tax savings you can collect too.
By TERESA TRITCH

(MONEY Magazine) – JUST STOP AND THINK ABOUT THE WAYS you'll be financing your child's future: college (for sure), a down payment on a house (increasingly likely), launching a professional practice (''anything for my daughter the doctor''), leaving a legacy (will it help them to remember?). Dissimilar as those events may seem, they all require a tax-smart strategy for shifting assets to your children, maybe even one featuring a trust. And this isn't an exercise only for the rich. Minimizing taxes is a crucial element in keeping any middle-income family's hard-earned savings from being eroded as it shifts assets from generation to generation. ''The techniques may vary according to your motivation, but giving your property away with the least tax hit is the common thread,'' says Richard Knight, a financial planner in Bellevue, Wash. Your first antagonist is income taxes. To build up a child's college fund, for example, you must adjust both the timing and the choice of assets you give to tame the five-year-old kiddie tax, which requires a child under age 14 to pay at the parent's top rate on investment income over $1,100. Then comes the onslaught of gift and estate levies. These so-called transfer taxes are essentially one and the same: gift tax is levied on transfers you make during your lifetime, while estate tax is imposed on property you leave at death; the rates kick in at 37% on taxable amounts above $600,000 and top out at 55% on sums above $3 million. In general, the strategy that is right for you depends on your child's age, on when you want him or her to have the money, and on the amount. Following are your three best choices, beginning with the simplest.

GIFTS Thanks to a soft spot known as the gift-tax exclusion in the otherwise stonyhearted tax code, you can make tax-free gifts of as much as $10,000 a year -- $20,000 if you give jointly with your spouse -- to each of as many people as you wish. If your good-heartedness rises above those benchmarks, the excess is subject to gift tax. The taxable amount of each gift isn't due immediately but is subtracted from your $600,000 estate-tax exemption when your estate tax is figured at your death. Giving cash or other property outright is usually suitable only for children who have reached the age of majority, 18 in most states. Because minors may be allowed to revoke otherwise legally binding contracts -- to sell stock or real estate, for example -- it is difficult to manage their property. Also, once you give an asset away, you legally have no say over what the recipient does with it. One useful variation on simply ceding assets to adult children: combining the gift-tax exclusion with a loan. Say you'd like to present your son and daughter-in-law with a $50,000 down payment on a house. If you and your spouse give them that amount, $10,000 will be subject to gift tax ($50,000 minus the two $20,000 joint gift-tax exclusions). If you lend the amount, however, you sidestep the gift tax. Then, as payments of interest and principal come due, you can forgive the indebtedness. As long as what is forgiven is less than the gift-tax exclusion amount, no gift tax will be assessed. Caution: although the IRS has lost court cases in the matter, it maintains that if you intended to make a gift all along, you owe a gift tax. To bolster your case, be sure to charge a market interest rate and to record a lien against the house. Your son and daughter-in-law should also meet the minimum credit standards that would qualify them for such a loan from any lender. ''By setting up the loan as a commercial transaction, you're not making any tacit or implicit gift,'' says Howard Black, a financial planner and attorney in Westbury, N.Y. ''So the parents can forgive the loan later out of generosity.''

CUSTODIAL ACCOUNTS For most parents or grandparents, the best way to give to young children is to open a no-fee custodial account at a bank, brokerage or mutual fund under the Uniform Transfers to Minors Act or, in some states, the Uniform Gifts to Minors Act. (UTMAs let you transfer a broad range of property, including cash, securities, life insurance, real estate and collectibles. UGMAs may be more restrictive, depending on your state law.) Your contributions to an UGMA or UTMA qualify for the annual gift-tax exclusion. Custodial accounts have two drawbacks. The first is avoidable: if you are both the donor and the custodian, the assets will be included in your estate if you die before the custodianship ends. For that reason, you should appoint a trustworthy and financially astute relative or friend as custodian. There is no defense against the second shortcoming: your child becomes the owner of the assets you place in the account. ''The custodian can spend the money for the benefit of the child -- say, for music lessons. But expenditures on items that are considered your parental-support obligation, such as food, clothing and shelter, are taxable income to the parents,'' says Kenneth Coveney, a tax partner at the law firm of Gray Cary Ames & Frye in San Diego. Once your child reaches the age of majority in most states, he or she will gain full control of the account. (In some states, like New York and Delaware, you can specify that the custodianship is to last until age 21. Review the rules in your state with a lawyer or tax adviser for further exceptions.) Whatever the age at which custodianship ends, few kids abscond with their college funds. But that's nonetheless a possibility you must consider. Some parents also worry that a custodial account may disqualify their child for college financial aid, since students are expected to contribute as much as 35% of their assets toward college costs, compared with less than 6% for parents. The solution: When your child begins high school, ask the college counselor to calculate whether your son or daughter is a candidate for aid. If so, restrict donations to the custodial account and save more in your own name as the time for college tuition approaches. In the early years, when your child is under age 14 and therefore subject to the kiddie tax, you might limit his or her custodial account to just enough income-producing assets to generate a maximum of $1,100 a year in earnings. The first $550 will be tax-free because of the child's standard deduction; the next $550 will be taxed at your child's rate, typically 15%. All together, a child's tax bill on $1,100 of unearned income would come to $83, vs. $308 if the income was earned in your name and you and your spouse are in the 28% bracket (taxable income of $34,000 to $82,150). Assuming a 7% return on the investment, a child under age 14 can accumulate assets of $15,715 before triggering the kiddie tax. If you put more assets than that into the account, consider growth stocks or growth mutual funds, particularly if your child has more than 10 years to go before college. Since such investments pay little or no dividends, you'll minimize or even avoid income tax. Furthermore, by waiting until your child turns 14 to sell the growth investments, you will avoid kiddie tax on the capital gain. Take, for example, Stephen and Patricia Tadolini of Lakewood, Colo. This year they established custodial accounts with stock mutual fund companies for their children Katie, 2, and Patrick, seven months. Katie's account, to which they've contributed $11,576, has already grown by $925, nearly all of it in capital gains. Patrick's account, launched with $1,500, is currently worth $1,700. ''So far the kids haven't had to pay any tax, and I don't even have to file a return for them,'' says Stephen. After your child turns 14 and the kiddie tax is no longer a problem, you can begin shifting money in the account to income investments. From that point on, all investment income is taxed at the child's rate, presumably 15%, vs. 28% or 31% for you. (For more about investing for college bills, see MONEY Guide: Best College Buys, available at newsstands for $3.95. Or send $4.50 to MONEY Guide: Best College Buys, P.O. Box 30626, Tampa, Fla. 33630-0626.)

TRUSTS If you have already accumulated enough for your child's college education or you plan to give him or her at least $100,000 over a relatively short period of time, like five years, trusts offer significant advantages over custodial accounts. True, establishing a trust can cost you a bundle in legal fees -- $500 to $2,000, depending on its complexity -- plus annual accounting fees of $250 to $500. But consider these merits of an irrevocable 2503(c) minor's trust, the best alternative for middle-income families: -- A trust can cut your income taxes, no matter how old your child. The first $100 of trust income is tax-free. The next $3,450 is taxed at 15%; the next $6,900 at 28%. Amounts above that are taxed at 31%. Thus the tax on $10,450 of trust income is $2,450, vs. $3,240 if the money was taxed at the parents' 31% bracket (taxable income above $82,150 for married couples). To get the most tax savings possible Howard Black, the Westbury, N.Y., planner and attorney, suggests distributing $1,100 (the kiddie-tax threshold) of trust earnings each year to the custodial account of a son or daughter under age 14. He or she will owe $83 of tax on the distribution; meanwhile, the trust can still accumulate as much as $3,550 in income and pay tax on it at 15%. Result: a total tax bill of $600 on $4,650 of earnings, vs. $826 if the entire amount accumulated in the trust, or $1,442 if the money was earned in the names of parents in the 31% bracket. You can realize even more dramatic tax savings by splitting trust income between the trust and a child over 14. If, for example, a trust earned $24,450 a year and retained $3,550, both that amount and the $20,900 that went to the child would be taxed at 15%. -- Gifts to a trust qualify for the annual gift-tax exclusion. Let's say that you, your spouse and all four of your child's grandparents contribute the tax- free maximum to the trust. The result: $60,000 added to it tax-free each year. In addition, as long as none of you serves as trustee and you leave the trust agreement unchanged, any subsequent appreciation on the assets that the donors place in the trust will also be removed from your estates. -- A trust gives parents some control over a child's access to the assets. Tax law stipulates that trust assets must be payable to the child at age 21. But you can add a provision to the trust document stating that if the child doesn't demand a payout, usually within 30 to 60 days of turning 21, the assets remain locked in the trust until a later date that you specify. Generally parents can persuade the child to leave the assets untouched, thus allowing the money to accumulate until the recipient is older and presumably more mature. That flexibility is a primary reason why Laurence O. Gray, 30, an investment adviser in Atlanta, is considering a trust for his son Justin, 4. To the father's surprise, the three custodial accounts he has funded for Justin's education are currently worth about $57,000; Gray projects they'll exceed $207,000 by 2004. ''As the custodial accounts grew, so did my concern that Justin could get all the money at age 21,'' he says. ''Instead of tempting him to spend it, I want to make sure he has something at ages 25, 30 and 35.'' One other trust is worth the attention of middle-income families with highly appreciated property. Since it will generate a big capital-gains tax if you $ sell it and even bigger estate levies if you keep it, consider a charitable remainder trust. Let's say you have real estate you bought for $30,000 that is now worth $200,000. When you place the property in a charitable remainder trust, the trustee -- it could be the tax-exempt charity -- can sell it and invest the proceeds without owing tax on the capital gain. As a result, the full $200,000 is available for investing, rather than $152,400 if you sold the property and paid the tax. You can stipulate in the trust agreement that a fixed percentage or amount of the trust be paid to you for life or as many years as you designate up to 20. You get a hefty charitable income tax deduction in the year you establish the trust, based on the trust's term, principal and payout rate. When the trust term ends, the remaining assets go to the charity. Some parents balk at such trusts because they would prefer that all their assets go to their children. With proper planning, however, you can mitigate that concern with life insurance. Take, for example, Vernon Garrett, 66, a retired accountant, and his wife Yvonne of Houston. They donated a half interest in their home to a charitable remainder trust benefiting the Memorial Foundation, a local hospital charity. By so doing, they avoided tax on the charity's share of the profit when the house was sold for $250,000 last year -- a $31,350 saving. The couple also garnered a $46,883 charitable deduction for the donation, based on a calculation that took into account the size of the donation and the fact that the Garretts named themselves beneficiaries of 5% of the trust value for life. Next, to compensate their five adult children for the loss of half the family home, the Garretts set up an irrevocable trust that contains a $100,000 life insurance policy with their children as equal beneficiaries. Since the policy is held in trust, its proceeds won't be included in the couple's taxable estates when they die. And the policy's proceeds to the kids will be free of income tax. ''Until someone figures out a way to take it with you,'' says Vernon Garrett, ''this is the next best thing.''