EXCLUSIONS AND DEDUCTIONS FROM THE FEDERAL GIFT AND ESTATE TAXES

In addition to the $1.5 million credit equivalent (exemption amount) for 2005 ($2 million in 2006), there are other exclusions and deductions from federal gift and estate taxes. These are:

Annual exclusions for lifetime gifts. Currently the annual exclusion is $11,000 ($12,000 in 2006) up from $10,000 in 2001. This can be given without tax consequences to each of an unlimited number of recipients. For example, a father may give each of his four children $11,000 tax-free per year ($44,000). If the mother chooses, she, too, can give each of her children $11,000 per year. In this example, the parents gave away $88,000 per year tax-free. The gifts are not restricted, so anyone may make the $11,000 annual gift to any other person tax-free. Large estate owners, therefore, can consider a program of lifetime giving in order to avoid missing out on significant wealth transfer tax savings.

The 1997 Tax Law introduced an annual inflation adjustment that increases the exclusion amount by $1,000 each time the annual adjustments add up to $1,000 or more. By 2002, the annual $10,000 exclusion from federal gift tax had increased to $11,000, and it will increase again to $12,000 in 2006.

Because these gifts are tax-free, they do not count against the estate tax credit equivalent. They require no paperwork and are income tax-free to the recipient. But to qualify, the gift to each recipient must be outright—a present right to spend or use the property—and not a promise of a future benefit. This requirement means that most gifts in trust would not qualify unless special provisions are made.

An unlimited marital deduction from gift and estate taxes. Gifts of any size to your spouse—lifetime or at death—do not "use up" any of the estate tax credit equivalent and are not included in the tax calculation.

Be careful. Many married couples avoid estate tax planning at an ultimate cost of many tens of thousands of dollars because they fail to take advantage of both of their unified credits. Most couples use the unlimited marital deduction to avoid estate tax on the first death. This leaves the whole estate to the survivor, and the estate often exceeds the unified credit equivalent amount. Furthermore, the estate continues to grow.

With a little planning, they could avoid unnecessary estate taxes by dividing their joint estate so each spouse takes advantage of their credits, and by using the marital deduction for amounts that exceed the unified credit equivalent. However, they can use a qualified professional to help do the math and to recommend appropriate estate planning tools.

An unlimited exclusion for gifts made in payment of another's medical or tuition costs. Payments must be made directly to the institution, not just earmarked for this use, and given to the beneficiary. Gifts to a bona fide charity. The IRS has a list of qualified charities.

The law makes possible a number of ways to lessen the gift and estate tax burden. Some are very simple; others are more complex and require the help of a qualified professional to implement.

We have seen that a little information can help you go a long way in saving gift and estate taxes. Let us now consider a few additional, not-so-obvious factors that may help you decide whether to use lifetime gifts, as opposed to transfers after your death, to pass your estate to your survivors.