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Tax Planning: Gift Tax

How is the federal gift tax liability is determined? Unlike the income tax which is based on taxable income for each year, the gift tax rate is based on the cumulative amounts of taxable gifts you make over the course of your life. Thus, as you make more and more taxable gifts, your gift tax bracket increases.

First, because of the annual exclusion, only gifts in excess of $11,000 to each donee are “taxable” in 2004.

Next, the gift tax on the first $1 million of taxable gifts you make during your life is covered by a gift tax credit. This credit wipes out the first $345,800 of gift tax liability. This is the liability that would arise from $1 million of taxable gifts. Accordingly, only after the taxable gifts you make during your life reach $1 million will any gift tax apply. The tax on gifts made in the current year is the tax on total lifetime gifts minus the tax on gifts made before the current year.

The taxpayer made no taxable gifts before 2001. In 2001, the taxpayer made $750,000 in potentially taxable gifts. The gift tax liability on this amount was $248,300, but the credit of $220,550 that was in effect in 2001 (exempting $675,000) reduced the actual tax bill to $27,750.

In 2004, the taxpayer makes an additional $250,000 in potentially taxable gifts. This brings lifetime gifts up to $1 million. The actual 2004 gift tax bill is zero, because of the increased gift tax credit of $345,800 (a $125,250 increase over the 2001 credit amount; $345,800 effectively exempts $1 million of gifts). But before application of the gift tax credit, the 2004 gift tax liability would be $345,800: a $248,300 gift tax liability in 2001 plus $97,500 on the 2004 gift of $250,000 taxed at a marginal bracket of 39%.

I should also note that under federal tax legislation enacted in 2001, the estate tax is repealed, effective 2010. However, the gift tax was not repealed, presumably to discourage taxpayers from making transfers to related taxpayers in lower income brackets. Therefore, the gift tax promises to remain a powerful consideration in the structuring of lifetime dispositions and in estate planning.

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