The reason this tax comes into play has to do with the estate tax. Without a gift tax, someone could give away all or most of their money right before death as a way to circumvent the estate tax. Now, you may also argue that the estate tax also isn’t fair, but that’s a discussion for another day.

There is some good news. First, the amount of the gift that triggers the gift tax is relatively high which means most people will never have to worry about it. Second, the gift tax threshold is reset annually, and is on a per-person basis. For 2010 and 2011, that individual annual amount is $13,000. So, if you have two children and you wanted to give them each $13,000 you could without triggering the gift tax. To sweeten the deal even further, the gift tax is an individual one, so if you’re married, you and your spouse can each give $13,000 to an individual each year, bringing the annual total up to $26,000.

In addition, there is a lifetime exclusion. Through the 2010 tax year your annual gift tax exclusion is $1 million. Beginning in 2011 that exclusion goes all the way up to $5 million. So, you can actually use the lifetime limit to actually give a recipient even more than the annual limit without triggering gift tax in that tax year. Here’s how it works:

Let’s say you wanted to give each of your two children $20,000 this year. That’s more than the $13,000 per person annual limit. So what happens is you give them the $20,000, but then the $7,000 excess for each would then be applied to your lifetime limit. In this case that’s $14,000 total that goes against your lifetime exclusion. You’d still have to file the IRS gift tax form to record this excess, but you wouldn’t owe any gift tax on that money.

Gift Exclusions

The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts.

• Gifts that are not more than the annual exclusion for the calendar year.
• Tuition or medical expenses you pay for someone (the educational and medical exclusions).
• Gifts to your spouse.
• Gifts to a political organization for its use.

For more information, check out this video by TurboTax: http://www.youtube.com/watch?v=nj9LNMHXamA

You might be thinking, “it’s my money and I’ll do with it what I want.” Nice thought, but not quite true. You needed to account for it when you earned it, and likely paid tax at that time, and you need to be aware of the rules for giving it away if that’s your intention. Why would you want to do that? The estate tax, also sometimes called the the death tax, is due to return with a vengeance next year unless congress acts. The estate tax exclusion has ticked up over the years, $3,500,000 in 2009, and this year going away altogether (in favor of a limited basis adjustment) but only to return to $1,000,000 next year. Gifting while you’re still alive can minimize or eliminate the potential estate tax. You know, few things say ‘I love you’ as well as a big check.

Let’s start with the simplest gift issue. You can give your spouse an unlimited of cash or anything of value with no gift consequences. If your spouse is not a citizen the limit is $134,000 for 2010 rising with inflation each year.

For anyone else, you may gift $13,000 per year per person with no tax due and no paperwork required. Your spouse has the same opportunity, so between you, that’s $26,000. If you have two children and they are married, you can see how this can multiply up pretty quickly.

There are some exceptions to this limit. You may pay anyone’s medical bill or higher education expenses with no concern for the limit. To avoid running afoul of the rules, the funds must be sent directly to pay the bill, you cannot send your child a check for $40,000 even if he writes his college a check the same day you’ve just gifted in excess of the limit. Gifts to qualified charities are also not subject to gift taxes regardless of the amount.

There is also an opportunity to transfer more than the $13,000 per person by taking advantage of the 529 college savings account. Current tax law permits you to gift up to 4 years in advance, i.e. a present gift of $65,000. This strategy will require a properly filled out Form 709 the gift return to claim this gift even though no tax is due.

If you exceed the limits, you can still avoid owing taxes by filing the 709 and use up a portion of your unified credit. Simply put, the credit covers the taxes due on the first $1,000,000 worth of assets left to a beneficiary or gifted. The math works out that the credit for gift tax is $345,800, but it’s easier to think of it as the tax on that $1,000,000 you can gift while you are alive, above and beyond any $13,000 gifts or other excluded gifts.

It’s also prudent to use the 709 to account for any large dollar transactions involving family. For example, you sell a house to a child for $250,000. Years from now, when you pass on, the IRS, while auditing your estate return, may decide that the house was worth far more and assess estate taxes. By filing the 709 and declaring the value of the transaction, you’ve started the 3 year clock on the IRS, once passed, the transaction cannot be questioned.

If you are in a position where gifting may be a strategy you are considering, be sure to understand the rules to avoid any mistakes that can be costly to you and your heirs. Any questions you wish to ask here, there are many ready and eager to help.

I’m not talking about donations to charities, but rather gifts from one person to another.  For example, parents decide to give money to a grown child who needs a down payment for a house. Or perhaps a sister wants to help out a brother who’s struggling financially.

For the year 2009, any person can give up to $13,000 to any other person without risk of having to pay a gift tax.

How an “IRS approved” gift works

What that means in practical terms is that a married couple, for example, could each give $13,000 to each of their two children. Thus each parent then could give as much as $26,000, for a combined total of $52,000 in 2009. Each child could receive as much as $26,000.

If the parents are feeling generous, they could also each give up to $13,000 to the wife’s unemployed brother. However, giver and receiver don’t have to be related.

By giving no more than the $13,000 limit, the giver avoids the possibility of having to pay a gift tax and the need to report the gift to the IRS.

One of the nifty things about the gift tax exclusion is that neither the giver nor the recipient has to report a gift on income tax returns. You can be generous and avoid the paperwork.  Just remember that if you don’t make a gift by December 31, the opportunity for 2009 goes away.