Lifetime Gifts

Since lifetime gifts and transfers at death are added together to calculate the unified transfer tax (the combined gift and estate tax), and taxed at the same rate, how can lifetime gifts can save you transfer taxes? Two reasons: the gift tax annual exclusion, and the fact that any appreciation in property value that occurs after the transfer is not taxable to the decedent's estate.

Annual gift tax exclusion. The gift tax annual exclusion generally allows you to transfer, each year, up to $14,000 in 2013 per donee (recipient) without incurring any gift tax liability and without reducing your estate's applicable exclusion amount. There is no limit on the number of donees that can receive gifts during the year. The annual limit is subject to adjustment each year due to inflation--it is $14,000 for 2013. These gifts are excluded from taxable gifts during your lifetime and excluded from the calculation of lifetime gifts that must be added to your gross estate for purposes of calculating the estate tax at the time of your death.

Spouses can treat a gift made by one spouse as made by both of them (this is called a "split gift"), even when only one of them actually owned and contributed the property.

Taken together, these provisions allow people to give away substantial wealth over time without incurring any tax liability. At the same time, they are reducing the value of the estate that will remain upon their deaths, thus minimizing the estate tax that must be paid later.

Example Eva, who owns a computer software company in her home state of Illinois, is extremely wealthy. Her husband, Henry, who is a school teacher, is not. In 2012, Eva gives $26,000 (which Henry agrees to treat as a split gift) to each of their four children. In this way, Eva can transfer $104,000 tax free in a single year. This amount otherwise might have been taxed as part of her estate at death. Imagine how this can add up quickly if she maintains this pattern on an annual basis!

Unified Credit Amount

If you give away more than the annual gift exclusion limit ($14,000 in 2013) to any one person in a year (or more than double that limit if your spouse consents to "split" the gift with you), the gift counts against your applicable exclusion amount ($5,125,000 in 2012 and $5,500,000 in 2013). Thus, if you give $114,000 to your child in 2013 (and you are single or your spouse doesn't join in the gift,) you used up $100,000 of your estate tax applicable exclusion, because any amount over $14,000 given to one person must be counted against the exclusion. The reduction is accomplished via the unified credit.

Appreciation in property value. Because any appreciation in the property's value after the date of the gift escapes transfer taxation, you can save future taxes by making gifts of property that is likely to increase in value. Assume the gift referred to above was not cash, but rather a piece of art worth $114,000 at the time of the gift. Also assume that when the donor dies 10 years later, the property is worth $250,000. Although the $100,000 must be counted against the applicable exclusion for the estate, the $137,000 increase in value during the 10 years escapes estate tax.