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My father passed away about ten years ago, and set up UGMA accounts with a family friend for college savings as part of the will. The UGMA were owned by our kid, with the family friend as custodian.

Upon turning 18, ownership moved directly to my child.

The IRS is asking for taxes on the entire amount transferred.

Ok, what probably happened is that they liquidated shares in the old account and transferred the proceeds to a new account, generating a 1099-B. When the IRS detects unreported gross proceeds, they have no sense of humor. They assume that for each sale:
1. There is no basis
2. It's all short-term.

It seems to me the initial amount in the UGMA account might be considered a gift and just the mutual fund earnings since account inception considered taxable earnings.

Not even that. The earnings should have been reported each year. And even so, your son may not have had a filing requirement. I'm a liitle curious why the family friend, and not you, was the custodian, but that's not my business, nor pertinent to the discussion. But if you had gotten the annual 1099s, I'm sure you would have dutifully seen to reporting any returns that were required.

I persume we do not get to split income into long term capital gains vs. income for a basic mutual fund (VTSMX).

Sure you do. But it sounds like the problem here is that nothing was reported.

Your starting point is to get the mutual fund statements for the year of sale, and actually, for all previous years, to be able to figure the basis of the shares liquidated, assuming that's what happened. And then respond to the IRS with a letter, enclosing a Schedule D with the correct numbers (and you may have to do a return for your son, if he has enough other income, or if the "kiddie tax" applies. And if he did file a return, maybe an amended return.) But first of all, you need the mutual fund statements. And you might need more than the 30 days on the letter to respond to IRS. I assume this letter has a 30-day deadline.

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