Financing for college with the Uniform Transfers to Minors Act

Make the zero rate for qualified dividends and net capital gain work toward building a college fund.
By Allen Ford, Ph.D., and Zac Wiebe, CPA

 Financing for college with the Uniform Transfers to Minors Act
Illustration by Nihat Dursun/iStock

Taxpayers with young dependent children who are starting to plan how to pay for college should not overlook the use of the Uniform Transfers to Minors Act (or Uniform Gifts to Minors Act) for some portion of their savings for college plans. With preferential treatment for qualified dividend income, a young child could earn $2,100 of dividend income in 2015 and have no income tax liability.

This article describes a simple strategy for accumulating tax-free income for a child's future use. The strategy requires some basic tax knowledge, but the tax provisions are not complicated if parents' goal is to have their dependent child earn up to $2,100 of dividend and/or net capital gain income annually. If the child has other combinations of income, the tax calculation can become more complicated.


Consider a young couple, the Parkers, with a child, Susie, born on Jan. 1, 2015. They invest $10,000 in an investment plan titled "under the Uniform Transfers to Minors Act." A parent may be the custodian of the plan, but income earned is gross income to the child unless it is used to provide for the Parkers' support obligations for Susie, such as food. The $10,000 is invested in a high-quality mutual fund or exchange-traded fund. For purposes of this example, the annual return is assumed to be 6%. After 18 years, Susie should have $28,540 available for her use without having paid any income taxes.


Because Susie is a dependent of her parents, her personal exemption deduction is zero, and her standard deduction is $1,050 in 2015. Susie has $600 of gross income but no taxable income and no income tax liability. In the second year, she has income of $636 and again has no taxable income or tax liability.

It makes no difference what type of income Susie earns in this example because she has no taxable income. It could consist of dividends, interest, short-term capital gain, and/or long-term capital gain.


If Susie's ordinary income tax rate is 15% or lower, her preferential tax rate for qualified dividend income is zero. A dividend distribution from a corporation is subject to double taxation because the earnings generating it are taxable to the corporation and the dividend is taxable to the shareholder. A distribution from an S corporation does not qualify for the preferential rate because the income generally is not taxed at the corporate level.

Net capital gain, which is the excess of net long-term capital gain over net short-term capital loss, also qualifies for preferential rates. Because there are different types of capital gains and different rates, this article considers only capital gains and losses due to the sale of marketable securities, excluding Sec. 1202 stock of a small business corporation.

If Susie has any combination of $2,100 of dividends and/or net capital gain, her taxable income for 2015 is $1,050 ($2,100 − $1,050 standard deduction), but her tax liability is zero because all of her income is preferential income taxed at a zero rate.


If Susie has $2,100 of net short-term capital gain and/or interest income, her taxable income is $1,050, and her tax liability is $105 (10% × $1,050). None of her income receives preferential tax treatment. Obviously, Susie prefers to have income subject to preferential rates, such as dividend income and long-term capital gain. However, if no more than $1,050 of her $2,100 gross income consists of income not subject to preferential rates, she will not have a tax liability.

For example, if Susie has $900 of net short-term capital gain in addition to $1,200 of net long-term capital gain and/or dividend income, her taxable income is $1,050, but she does not have a tax liability. Of her income, $1,050 is subject to tax, but, fortunately, it is considered to be $1,050 of preferential income taxed at a zero rate. In essence, the $900 of net short-term capital gain is offset by her $1,050 standard deduction, and her $1,050 of taxable income consists of preferential income taxed at a zero rate.

To summarize, if Susie has $2,100 of gross income, and income not subject to preferential rates is $1,050 or less, her tax liability is zero. The $1,050 of her income that is taxed qualifies for the preferential rate of zero.


Based on the above results, Susie's parents might consider investing a larger amount than $10,000. If $40,000 is invested and a 6% return is earned, Susie could have $2,400 of gross income and taxable income of $1,350 ($2,400 − $1,050 standard deduction). Because of the kiddie tax, $300 ($2,400 — (2 × $1,050)) of Susie's income is taxed at her parents' rate. The kiddie tax has a negative effect on a parent's attempt to shift income to a dependent child.

The kiddie tax will apply when Susie is less than 18 years old and has net unearned income (i.e., her unearned income exceeds two times the $1,050 standard deduction). The kiddie tax may also apply when Susie is 18 to 23 years old, as explained later. If Susie has $2,100 of income not subject to preferential rates, such as interest income, her taxable income is $1,050, and her tax liability is $105 (10% × $1,050). None of her taxable income is taxed at her parents' rate. However, if her income is $2,800 instead of $2,100, then $700 of her income is net unearned income taxed at her parents' rate.

There is no tax advantage for Susie to have net unearned income because the parents' higher tax rate is used for the net unearned income.


Gifts that are less than the annual gift tax exclusion are not subject to the gift tax. Thus, one parent could give $14,000 to Susie in 2015 without having a taxable gift possibly subject to the gift tax. If the Parkers want to invest more than $14,000 in Susie's investment account, they can each make a gift of $14,000 or less without creating a taxable gift, or one can make a gift of $28,000 or less, and they can split the gift. However, if the couple split a gift, they must file a gift tax return (Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return).

As custodians, the Parkers have control over the property in the investment account, but the property must be distributed to Susie when she reaches the age of trust termination, which is determined by statute and in most states is age 21. If Susie dies before age 21, the property in the investment account will belong to her parents.

If the custodian dies before Susie turns 21, the property in the investment account is included in the custodian's gross estate if the custodian created the investment account for Susie. For 2015, if the custodian has not previously used any of his or her lifetime estate and gift tax exclusion amount, the custodian's estate generally will not be subject to an estate tax if the taxable estate is not more than $5,430,000.


Many taxpayers contribute to a state-operated Sec. 529 education savings plan to save for college. Contributions are not deductible for federal tax purposes, although they may be deductible when computing state income tax. In one type of 529 plan, educational institutions may treat contributions as prepayments for future college expenses.

Earnings on the amount invested are not subject to tax currently and will not be taxed if distributions from the 529 plan are used to pay the beneficiary's qualified higher education expenses. If distributions are used for other reasons, they generally will be subject to tax and a 10% penalty. Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for a designated beneficiary at an eligible educational institution. The costs of room and board are also qualified expenses for students who are enrolled at least half-time.

Sec. 529 plans are a popular way of saving for college, but the Parkers should first consider contributing at least $10,000 to an investment account for Susie with the goal of generating preferential income. The major advantage of having funds in her investment account is that the funds may be used for any purchase without a negative tax effect. If assets in the 529 plan are used for expenses that are not qualified higher education expenses, Susie generally must include the amount used to pay those expenses in her gross income, and a 10% penalty is assessed on that amount.

The investment account could even be the start of Susie's retirement plan if it is not needed for college. If so, the advantage of starting a retirement plan early will become apparent. Although the income at 6% annual growth for the first year was $600, it will be $1,712 in year 19.

Some parents may not want their children to have so much flexibility, but the Parkers will retain control until Susie reaches age 21.

The 529 plan does have an advantage in eligibility for federal financial aid. Assets in the 529 plan will be counted as owned by the Parkers, while Susie will be the owner of the investment account, giving it more weight in financial aid calculations such as that of the Free Application for Federal Student Aid (FAFSA).


In 2015, the standard deduction for one who is a dependent of another taxpayer is the higher of $1,050 or earned income plus $350, but not more than the regular standard deduction amount ($6,300 for 2015). If Susie is 14 years old instead of 1 and earns $3,000 from a part-time job in 2015 plus $2,000 of dividend income, her taxable income is $1,650 ($5,000 − $3,350). However, all of her taxable income is dividend income taxed at a zero rate. If her $2,000 of investment income consists of interest income (or other income not subject to preferential rates) instead of dividend income, her tax liability is $165 (10% × $1,650).

If Susie's $2,000 of investment income consists of $800 of interest income and $1,200 of dividend income, her taxable income is still $1,650, but her tax is $45 ((10% × $450) + (0% × $1,200)).


When Susie is 18 years old, she may still be subject to the kiddie tax if her earned income does not exceed one-half of her support for the year.

If Susie were 18 years old in 2015, did not have earned income in excess of one-half of her support, and had interest income of $2,500, her taxable income would be $1,450 ($2,500 − $1,050). If her parents' tax rate is 35%, she must use the 35% for $400 of her taxable income because it is unearned. Her tax is $245 ((10% × $1,050) + (35% × $400)).

However, assume that Susie has $2,500 of dividend income instead of interest income and note the difference in tax. Her tax is only $60 ((0% × $1,050) + (15% × $400)). Although she is subject to the kiddie tax and must use her parents' tax rate to compute her tax, her parents' tax rate for dividend income is 15% if their regular tax rate is more than 15% but less than 39.6%.

Susie will continue to be subject to the kiddie tax if she is a full-time student age 19 to 23 and has earned income that does not exceed half of her support.


If Susie (assuming again she is born in 2015) has only income subject to preferential tax rates and her account grows by exactly 6% each year, for year 18, she has $1,616 of income subject to preferential tax rates. Because Susie still earns less than the $2,100 limit (which will probably be higher due to inflation adjustments of the standard deduction), she could have been receiving more income without having a tax liability.

It seems clear that the Parkers should probably invest more than $10,000 in 2015, but the optimum amount is uncertain because of the necessary assumptions about how and when the income is earned, and how much higher Susie's standard deduction might be in 18 years.

The standard deduction amount has increased in the past about every two or three years, as shown in "Standard Deduction for Dependent of Another Taxpayer."

Standard deduction for dependent of another taxpayer


If Susie were 10 years old in 2015, creating an investment account for her should still be advantageous, but the account will be unable to increase as much as in the original example. Using the same assumptions as before, she would have $16,895 in her account when she reaches age 19. The earnings for the year she is 18 years old are $957, considerably less than what she could earn without having a tax liability. The Parkers might decide to invest $20,000 or even more if Susie is 10 years old when they create her investment account.


Taxpayers who want to accumulate funds to help their children and/or grandchildren attend college should first consider using the Uniform Transfers to Minors Act to create an investment account for the minor. With the standard deduction and certain income subject to preferential tax rates, given a long enough time horizon, a sizable account can be accumulated without paying any income tax, and the money can be used for many purposes. 

About the authors

Allen Ford ( is the Larry D. Horner/KPMG Distinguished Professor of Accounting at the University of Kansas in Lawrence. Zac Wiebe ( is a doctoral student in accounting at the University of Kansas.

AICPA resources

JofA article

"The Dreaded Kiddie Tax," July 2007, page 55


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