Gifts in excess of the applicable exclusion amount.

• Author: Ransome, Justin P.

The increase in the unified credit (now referred to as the applicable credit amount), enacted as part of the Taxpayer Relief Act of 1997 (the TRA '97), enables taxpayers who have made gifts in excess of the "old" unified credit to make additional gifts without incurring gift tax. However, a taxpayer in these circumstances must cautioned that the incremental increase in the applicable exclusion amount may not be fully available. The taxpayer's ability to take advantage of this incremental increase depends on the amount of gifts made in prior years.

The TRA '97 removed the term "unified credit" from the estate and gift tax laws and, for estates of decedents dying (and gifts made) after 1997, replaced it with the term "applicable credit amount." This is the amount of the tentative tax that would determined using the rate schedule in Sec. 2001(c), if the amount with which such tentative tax is to be computed is the applicable exclusion amount. This amount is quantitatively defined under Sec. 2010(c) as a specific dollar amount corresponding to a specific year. The applicable credit amount and the applicable exclusion amount are periodically increased over a nine-year period, maximizing in 2006 at $345,800 and $1 million, respectively.

The unsuspecting taxpayer who made cumulative gifts before 1998 in excess of the old unified credit may believe that he may make additional gifts equal to the incremental increase in the applicable exclusion amount without incurring gift tax. However, this may not be the case; the focus should be on the incremental increase in the applicable credit amount. Also, because the estate and gift tax are subject to graduated tax rates, the taxpayer's marginal tax bracket for the total amount of taxable gifts made in prior years will determine how much can actually be made in taxable gifts in a year in which there is an increase in the applicable exclusion amount without incurring gift tax in such year.

Example 1: A taxpayer (T) has made $900,000 in taxable gifts through 1997 and intends to make $25,000 (the incremental increase from 1997 to 1998 in the applicable exclusion amount) in taxable gifts in 1998. One might assume that T would not owe $500 in gift tax for 1998. This results because T was in a higher marginal gift tax bracket (39%) for his taxable gifts in prior years than the marginal gift tax bracket (37%) that corresponds to the applicable exclusion amount. T has lost 2% of the "power" of the incremental...