Gift taxes: getting shortchanged by the $25,000 lifetime exemption increase.

• Author: Harrison, Robert E.

The Taxpayer Relief Act of 1997 (TRA '97) increased the lifetime unified credit amount for estate and gift tax purposes. The unified credit is available for use against both gift tax on taxable lifetime gifts and estate tax imposed on transfers at death.

Under prior law, the unified credit amount was $192,800, which effectively exempted from tax the first $600,000 of taxable lifetime gifts and transfers at death. For decedents dying and gifts made during 1998, the unified credit amount has been increased to $202,050, which effectively exempts from tax the first $625,000 of taxable lifetime gifts and transfers at death.

The TRA '97 also provides for increases in the unified credit amount after 1998. These increases are being phased in over a number of years such that, by the year 2006, the unified credit amount will be $345,800, effectively exempting from tax the first $1 million of taxable lifetime gifts and transfers at death.

Maximizing lifetime gifts is a powerful tool in estate planning, as they have some advantages over transfers at death. Transferring asset ownership before value appreciates makes lifetime giving attractive. In addition, the estate tax is imposed on the total fair market value of assets owned at death, including the assets from which the estate tax will be paid. On the other hand, gift tax is based only on the value of the assets transferred. Because the cash used to pay the gift tax is not considered part of the taxable gift, a larger amount can be transferred by using lifetime gifts rather than transfers at death.

Many taxpayers take advantage of the $10,000 per-year, per-donee exclusion from the gift tax. Over and above this annual exclusion, taxpayers who have already completely used their $600,000 lifetime exemption via past lifetime gifts should consider taking advantage of the increase by making a "1998 additional gift" of as much as $25,000. However, taxpayers who have made significant taxable gifts in the past may be surprised to learn that they will owe some gift tax on this additional $25,000 gift.

For taxpayers with cumulative taxable lifetime gifts not exceeding $750,000 (including consideration of a 1998 additional gift), no gift tax will be due on the 1998 additional gift. Taxpayers who can expect to be "shortchanged" by the lifetime exemption increase are those whose total cumulative taxable lifetime gifts, plus the 1998 additional gift, exceed $750,000.

This occurs because the unified gift and estate...