Since lifetime gifts and transfers at death are added
together for purposes of the unified transfer tax, and taxed at
the same rate, how can it be that 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. A special provision, called
the gift tax annual exclusion, generally allows you to transfer,
each year, up to $10,000 per donee in 2001 ($11,000 in
2002) without incurring any gift tax liability. Any amounts
excluded this way are not included in your gross estate for
purposes of the estate tax.
Another wrinkle on this rule is that spouses are allowed to
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 wealthy people to give
away substantial sums of money over time.
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. Each year, Eva gives $20,000
(which Henry agrees to treat as a split gift) to
each of their four children. In this way, over
the next 10 years, Eva will transfer $800,000
tax free which otherwise would have been taxed
in her estate at death.
If you give away more than $10,000 to any one person in a
year (or more than $20,000 if your spouse consents to the gift),
the gift counts against your unified credit amount, which is
$675,000 for 2001. Thus, if you give away $110,000 to your
child, your estate tax exclusion has just dropped by $100,000.
This is not necessarily bad. Because any appreciation in the
property's value after the date of the gift escapes transfer
taxation, you can save future taxes by giving away property that
is likely to increase in value. Ignoring the annual exclusion
for this example, assume that an individual transfers property
that is now worth $20,000. When the donor dies 10 years later,
the property is worth $200,000. Although the $20,000 is included
in the computation of property subject to the unified transfer
tax, the $180,000 escapes taxation.
If he is really worth an estimated $47
billion, and his wife agreed to split gifts,
Bill Gates could make gifts of $20,000 to
2,350,000 people this year, and still not have
to pay any gift tax!