In this trust, annual income may be accumulated in the trust and not paid out. However, the trust provisions must provide that, if necessary, both principal and income can be used for the child’s benefit. If the trust provisions are worded this way, then the trust will qualify for the $10,000 gift tax exclusion. The only drawback to this trust is that all of the trust’s assets must be distributed when the child turns 21. If the child dies before turning 21, then the trust assets must be distributed to the child’s estate or in a manner that the child appoints.
This trust can only be set up to benefit a minor, and the trustee must be given the authority to use the assets for the benefit of the minor without restriction. Also, the trust assets must be invested in income-producing assets such as stocks, bonds, and CDs.
For income tax purposes, the trust pays income tax on income it does not distribute and the child pays income tax on income distributed to him/her.