Lifetime Gifts

Since lifetime gifts and transfers at death are added together for purposes of the unified transfer tax, and taxed at the same rate, how can it be that lifetime gifts can save you transfer taxes? Two reasons: the gift tax annual exclusion, and the fact that any appreciation in property value that occurs after the transfer is not taxable to the decedent's estate.

Annual gift tax exclusion. A special provision, called the gift tax annual exclusion, generally allows you to transfer, each year, up to $12,000 per donee (recipient) in 2006 and 2007 without incurring any gift tax liability. Any amounts excluded this way are not included in your gross estate for purposes of the estate tax.

Another wrinkle on this rule is that spouses are allowed to treat a gift made by one spouse as made by both of them (this is called a "split gift"), even when only one of them actually owned and contributed the property.

Taken together, these provisions allow wealthy people to give away substantial sums of money over time.

Example Eva, who owns a computer software company in her home state of Illinois, is extremely wealthy. Her husband, Henry, who is a school teacher, is not. Each year, Eva gives $24,000 (which Henry agrees to treat as a split gift) to each of their four children. In this way, over the next 10 years, Eva will transfer $960,000 tax free which otherwise might have been taxed as part of her estate at death.

If you give away more than $12,000 to any one person in a year (or more than $24,000 if your spouse consents to join you in the gift), the gift counts against your unified credit amount, which is $2 million in 2006 through 2008. Thus, if you gave away $112,000 to your child in 2007, your estate tax exclusion has just dropped by $100,000.

This is not necessarily bad. Because any appreciation in the property's value after the date of the gift escapes transfer taxation, you can save future taxes by giving away property that is likely to increase in value. Ignoring the annual exclusion for this example, assume that an individual transfers property that is now worth $20,000. When the donor dies 10 years later, the property is worth $200,000. Although the $20,000 is included in the computation of property subject to the unified transfer tax, the $180,000 escapes estate tax taxation.

Did You Know? If he is really worth an estimated $24.52 billion (based on Microsoft's current stock price), and his wife agreed to split gifts, Bill Gates could make gifts of $24,000 to 1,021,667 people in 2007, and still not have to pay any gift tax!