How Can Gifts Help You Reduce Your Estate Taxes?

By: Kris Koonar

US laws heavily tax the estate of a deceased person if the value of the estate exceeds certain limits. For the year 2007 and 2008 this limit is fixed at $2 million. 2009 will see this limit climbing to $3.5 million. The rate of taxation for the amount above the exemption limit is a flat 45%. Every dollar above the limit will lose 45 cents to estate taxes.

There are many ways to avoid or mitigate estate taxes. Transferring property through gifts is one of them. As a general rule, all gifts excluding certain exceptions are subject to gift tax. The exceptions for are :-

Gifts made to ones spouse
Gifts to political organizations for their use
Gifts to charities.
Gifts to cover someones tuition or medical expenses paid directly to an educational institution or medical service provider.
Gifts up to $12000 to a person in one calendar year. This is known as Annual Exclusion.

The lifetime exclusion limit for each taxpayer is $1million. Therefore, any number of $12000 gifts would remain non-taxable even if made in one calendar year but to different persons. You can lower the size of your estate during your lifetime through gifts to escape the estate tax net.

Gifts can be used in estate tax planning by using the annual gift exclusion. Although the annual exclusion limit of $12000 may not appear to be much on the face of it, it can serve to substantially lower the estate size over a period of time. Let us examine how it can do this.

You give $12000 dollars each year to a son/daughter/any other person and pay no tax. In this case, no gift tax return is to be filed. If married, the amount doubles as your spouse is entitled to make a non-taxable gift of a similar amount. This amounts to $24000 a year to a married couple. Now for a person with four children, who receive similar gifts, the amount would total to $96000 every year. When the children are married and the spouses also receive similar gifts the amount of the total non-taxable gift in a year comes to $192,000. This way over a period of five years, one can make TAX FREE transfer of wealth from the estate and lower its taxable value by a figure close to $1Million!

Considering this $1million to be above the estate tax exemption limit, at present rates it would attract an estate tax of $450,000 if allowed to pass on to heirs by inheritance after death.

As already discussed, a married couple can make tax-free gifts of $24000 each calendar year. Even when the gift amount is not evenly contributed by them, they can still make a taxless gift up to that amount by taking advantage of the gift splitting provision.
Both partners must agree to take advantage of gift splitting and each will have to file a gift tax return by filling form 709. Both returns need to be filed even when Below the Exemption Limit Share of one partner does not require a return to be filed in the usual course. Let us examine how this works.

A married couple A and B together gift a total of $39000 to two persons. A gifts $21000 to his nephew C and B gifts $18000 to her niece D. Both gifts are above $12000 and liable for gift tax.

By filling Form 709 for Gift Splitting, As $21000 is treated as being given in equal amounts of $10,500 both to C and D which is within exemption limits. Similarly, Bs $18000 is again treated as being given in equal amounts of $9,000 each to C and D that is within exemption limits. This way a substantial gift tax that would otherwise have been payable on both the gifts is saved through gift splitting.

You can also make gifts without any limits to your spouse without any tax being applicable. This would lower your estate tax liability and can even eliminate it if it can lower the size of your estate to that extent. However, the amount would be taxable in the estate of your spouse on his/her death if the estate were larger than the exemption limit unless suitable plans are implemented before the second death to take care of applicable estate taxes. Other non-taxable gifts mention earlier can also help reduce estate taxes through proper use.

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