The power of gifting.

• Author: Tierney, Thomas G.

Prospects for repeal of the estate tax became less likely after the November 2006 elections; as a result, gifting continues to be a powerful estate planning tool. Maximizing use of the annual gift tax exclusion, using the $1 million lifetime gift tax exemption and gift-splitting by married couples, can help reduce the size of a taxable estate. The younger the individual using these tools, the better the results.

Current Exclusion/Exemption Amounts

The current annual gift tax exclusion is $12,000 per donee, under Sec. 2503(b)(1). This amount is indexed for inflation under Sec. 2503(b)(2) and could rise in the future. Any annual gift tax exclusion not used in a calendar year is lost; there is no carryover.

The current lifetime gift tax exemption is $1 million, under Sec. 2505. This amount had been tied to the estate tax exemption, but currently is fixed at $1 million, even though the estate tax exemption is scheduled to change in the future (currently under Sec. 2010(c), $2 million for 2007 and 2008; $3.5 million for 2009; full exemption in 2010; and $1 million in 2011).

Reducing the Estate

Annual gift tax exclusion: Making a $12,000 gift will likely reduce the donor's estate by more than $12,000 (because had the gift not been made, the asset would likely have increased in value).

Example 1: X, a 50-year-old, makes a $12,000 gift in 2007; there is no gift tax because of the annual exclusion. If X lives to age 70, the $12,000 would otherwise have grown to $38,486, assuming a 6% annual rate. Thus, a $12,000 gift made 20 years before death would decrease the total estate by $38,486 (more than 3.2 times the original gift amount). If the gift were made 10 years before death, the estate reduction would be $21,490, approximately 1.8 times the original gift. However, because the $12,000 exclusion is available each year, a consistent gifting plan could result in a significant reduction to X's eventual estate.

Estate tax exemption: The $1 million estate tax exemption can be used now or later. To the extent that it is used during life to reduce taxable gifts, it is not available for estate tax purposes, making it somewhat less valuable than the annual gift tax exclusion. However, as with annual-exclusion gifts, asset growth from the gift date until death is removed from the estate.

Example 2: Y, 50 years old, makes a $1 million gift in 2007 and elects to use his estate tax exemption; thus, he will not be subject...