Your question may raise more than just a tax issue. Generally, under the Uniform Transfers to Minors Act (UMTA), money deposited into a UTMA account can't be withdrawn for any reason—except by the child at the appropriate age. Although, there may be some circumstances when a parent custodian can withdraw funds from a UTMA for the benefit of their child but there are conditions on how these funds can be handled. Leaving aside any legal issue, let's focus on the tax issue.
There are no IRS penalties on taking money out of a UTMA account. Profits made on the liquidation of investments in a child’s UTMA account are generally reported on the child’s tax return, but some or all might be included on the parent’s tax return, at the parent’s tax rate, depending on how the family files its federal taxes. The fact that you returned some of the funds withdrawn does not negate the requirement to pay whatever taxes are due on the full amount withdrawn. The fact that some of the funds were re-deposited back into the account merely represents another irrevocable gift to the beneficiary.
As noted herein, a parent may be able to elect to report the beneficiary child's interest, ordinary dividends, and capital gains distributions on their return. If a parent make this election, the child won't have to file a tax return. To make this election, attach Form 8814 to your Form 1040 if the child meets all of the following conditions.
- At the end of the tax year the child was under age 19 (or under age 24 if a full-time student).
- The child's gross income was less than $11,000 for the tax year.
- The child had income only from interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends).
- No estimated tax payments were made for the child for the tax year, and no overpayment from the previous tax year (or from any amended return) was applied to the current tax year under your child's name and social security number.
- No federal income tax was withheld from the child's income under the backup withholding rules.
- The child is required to file a return unless you make this election.
- The child doesn't file a joint return for the tax year.
- You are the parent qualified to make the election or you file a joint return with your child's other parent.
Here is a link to an IRS webpage that discusses the tax on a child's investment and other unearned income which you might find helpful.
The Tax on a Child's Investment and Other Unearned Income
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