I have heard that there is a tax benefit in making gifts of $13,000 per year to my children. What is this all about?

What this refers to is the value of gifts you can make to a person during the year without incurring a liability for Federal Gift Taxes. (Before the Estate and Gift Tax laws began changing a number of years ago, the amount of this exemption was $10,000, and many people still remember this dollar amount. But it is actually $13,000 in the year 2009.) There is a great deal of confusion about this tax benefit.

First of all, the benefit is not a deduction from income taxes. Since receiving gifts does not result in income tax liability to the recipient, making a gift to an individual does not give the donor any income tax benefit. There may be an indirect income tax benefit as income-producing property is transferred to others, but that is the subject of another article.

The benefit we are talking about is an exemption from the Federal Gift Tax. The Gift Tax is a tax imposed on the value of gifts made during your lifetime. It is similar to the Federal Estate Tax in many respects, except that there is only a $1,000,000 lifetime Gift Tax exclusion compared to the $3,500,000 Estate Tax exemption. In a number of respects, the Gift Tax and Estate Tax laws work together. For example, if the total value of gifts you make does not exceed $1,000,000, there is no gift tax. However, gifts that you make in excess of the $13,000 annual exclusion will reduce your Estate Tax exemption, dollar-for-dollar even though no Gift Tax has to be paid. For example, if you make $500,000 in gifts during your lifetime, your Estate Tax exemption will be reduced from $3,500,000 to $3,000,000.

What the $13,000 annual gift tax exclusions does is to enable you to make gifts of up to $13,000 per donee, per year, without affecting either your $1,000,000 Gift Tax exemption or your $3,500,000 Estate Tax exemption. For many people, this feature makes lifetime gifts an extremely valuable tool. For example, a parent can give $13,000 per year to each of five children, with the result that the value of the estate otherwise subject to Estate Tax is reduced by $65,000 per year (five children times a $13,000 exemption for each child) while retaining the full Gift Tax and Estate Tax personal exemptions.

To add to the advantage (and confusion) of the Gift Tax annual exclusion, the annual exemption for gifts by a married couple can be doubled, so in the example above, a married couple could give $26,000 per year to each of their five children and reduce their combined taxable estate by $130,000 per year. In addition, if the parents feel optimistic about their children’s marriages, they could double the amount of exempt gifts still further by including the spouses of their children. Still more gifts could be made to grandchildren (although there are special rules about gifts to minors), nieces, nephews, friends, etc.

Obviously, this discussion is not important for those whose estates do not now and probably never will exceed $1,000,000. You can, however, impress your friends at your next lodge meeting by discussing the topic authoritatively. Many of you, even with large estates, are now saying, “Why in the world would I want to give away my hard-earned cash (or stocks or real property or anything else) to my ungrateful children. I earned it; not them. I went through The Depression, and who knows whether I might someday need this four or five million dollars I have stashed away.” In addition, there are circumstances where even a large estate should be retained for projected future expenses, if substantial medical expenses, for example, are expected. Frankly, these are legitimate responses and may decide the issue for many of us.

For those with large estates who are sincerely interested in minimizing taxes, however, making each $13,000 gift can save their family nearly $6,000 in real money, in federal estate taxes otherwise payable at death. While the beneficiaries of large estates may still inherit a substantial sum even after paying Estate Taxes, nobody should go to his or her grave knowing that a little stubbornness made it necessary for their children to write a 6- or 7-figure check to the Internal Revenue Service. This is an expense that might be avoided, or at least minimized, by the use of these annual gifts, especially if they are made to those persons who will be inheriting the estate eventually, anyway.

(This article was last revised in the year 2009. The Gift Tax and Estate Tax laws are expected to undergo change, possibly as early as this year. You should consult with your own attorney or accountant to confirm the current rates of tax and amounts of exemptions.)