Children's Surrogate Account - Interest Income

[Yardley CPA]

Husband and wife filing MFJ.  Their two children both have investment income in excess of $2,100 so I plan on preparing form 8615.   One of the children has interest income from a bank that indicates it is a surrogate account.  Should the amount from the surrogate account be included when determining the investment income?

[Abby Normal]

I've never heard of a surrogate account. Whose SSN is on the 1099?

[jklcpa]

I've never heard the term either and found only the one answer shown below from within a Yahoo Q&A when searching for that term related to bank accounts.  From that, I'd report the income as belonging to the person whose SSN is on the 1099. 

Quote

When the bank account was originally established by your Mother, both of your names were put on the account, she as the co-owner and you as the minor child. When a financial institution refers to a co-owned bank account as a Surrogate account, it usually refers to a legal situation involving courts and/or an inheritance. 

Each state would have rules for how you can access this co-owned account and the bank should be able to assist you by describing the documents and forms you require to withdraw money from the Surrogate account. Do not deal with the teller at the counter, but ask for help from one of the bankers who will have more understanding of the process you must take to access the account funds.

  

[Yardley CPA]

Thank you, Both.  The 1099-INT is in the Childs SSN.  Mother is listed under the child's name with GDN after her name.  I assume that means "Guardian?"  In any event, I've asked the mother for additional information on the specifics of the "surrogate account."  I prepared the returns assuming all the children's income was taxable.  The mother is questioning whether the surrogate account interest is taxable.  

[jklcpa]

Ok, parent is a guardian for these funds of the minor child. The child is the legal owner of the assets with guardian having a fiduciary responsibility.  Taxable earnings would be the child's. Why does the parent think the earnings wouldn't be, or wouldn't be taxable?

Good info here on different types of accounts:
https://info.legalzoom.com/difference-between-guardian-account-custodial-account-23481.html

Edited September 8, 2018 by jklcpa
added the sentence on legal & fid.

[Yardley CPA]

JKL...that's what I'm trying to determine.  Not sure why she feels the "surrogate" impacts the taxability of the earnings.  I asked her for additional info.  I don't think that will make a difference but I would like to know more about the situation.  

[Max W]

Whoa! when I Googled "surrogate" all I got were links to surrogate mothers.  It must be a hot topic.

If it is the mother's natural child, it would be a Custodial acct. (Thanks, Judy).

If the mother was appointed guardian of a someone elses child, and the mother was legally appointed guardian, it would usually be a guardian account.

However, it seems that in some states, they use "Surrogate" for both custodial and guardian accounts. Maybe PA is one of them.

It may be that the child is adopted and the account was opened between the time the mother was appointed guardian and before any adoption was finalized.

Yardley, I would simply tell the mother that it does not matter what the account is called, it is the SSN on the account is all that matters and any interest over $0.50 has to be reported.

 

 

[Yardley CPA]

Thank you, All.  The mother shared, the son is naturally born and received funds from an insurance company due to an accident settlement.  The funds remain in this "surrogate" account until he is 18.  My initial reaction was...It's taxable and I still feel that way.  I appreciate everyone's input and thoughts.  It's great to have this forum to turn to.  

[jklcpa]

Yardley, it IS taxable and is the child's, subject to the kiddie tax.  I had this exact scenario years ago at the firm I worked for.  Four minor children each received a huge settlement from a small plane mfr after it was found negligent in the deaths of both parents.  The god parents had taken them in and adopted them as their own before ever knowing if any settlement would occur.    

[SaraEA]

I think the mom is confusing the settlement and the interest earned on the settlement.  Perhaps the settlement itself was not taxable (personal injury or whatever).  But the proceeds were put into an interest-bearing account and that interest is taxable.  I had a client whose house burned down.  He got a large insurance settlement, never rebuilt, and eventually sold the land.  Both the insurance and the sales monies went into his brokerage account, which earned lots of income.  He had a fit when he learned how much taxes he owed and insisted that "I" was taxing him on his insurance payout.  Fortunately his son and broker understood.  They now have 90% of his RMD withheld for taxes (which he doesn't notice), so he gets a small refund and loves me again.

[Catherine]

On 9/8/2018 at 11:20 AM, Yardley CPA said:

The mother is questioning whether the surrogate account interest is taxable.  

From the 16th Amendment (that legalized income taxation):  "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived....."

If it's income, it is subject to taxation, unless specifically exempted.  Your return question should be why she thinks it is exempt.  Yes, it might be interest on a settlement.  Yes, the settlement might be exempt - but NOT what it earns.  Get her to tell you what she thinks and you'll know how to debunk her error.