Gifting to Reduce Estate Taxes

You've worked hard. You've spent wisely, saved wisely and invested wisely. You've achieved your dream and accumulated plenty of wealth to pass on to your loved ones when you die. Your will is written and safely filed away.

Unfortunately, if you keep all of your wealth until you die, your loved ones may not actually get everything you intend for them to. They could have to pay an estate tax on all that money and all of those things you've worked so hard to protect. That could conceivably be a tax of 39% or higher.

The estate tax is defined on the IRS website as "a tax on your right to transfer property at your death." If you choose not to exercise that right, you (or more accurately, your loved ones) won't be subject to that tax. So what do you do with all that money and all those things you want them to have? Gift it to them now, before you die.

You can gift your loved ones their inheritance and, if you follow the rules, neither of you will have to pay taxes on it. The rules are pretty simple: keep your gift amounts/values less than $12,000 per individual per year. That's right: you can give as many people as you want gifts of money or property valued at less than $12,000 in any calendar year tax-free. If you give someone more than that, you have to pay the gift tax on the amount over $12,000.

Let's say for example you've planned on leaving your son your classic car valued at $48,000. If you wait until the reading of the will, he will have to pay an estate tax of about 39% on the full value of the car. You could go ahead and give him the car now, but then you would owe a gift tax on the difference between the value of the car and the $12,000 annual limit: $36,000.

However, you could gift him a 1/4 share of the car (legally, with the help of your attorney) each year for the next four years. At the end of the four years the car would be his and neither of you would have had to pay any additional tax.

If you are married, it gets even better. If they agree, spouses can combine their annual gifts: $24,000 cash or property, per recipient, per year-tax free. So if you and your spouse agree about giving your son that classic car now, you could gift him a half of the car this year and half next year and the car would be his.

If you wanted to gift the car to your son and his wife, as another couple that would double the amount you and you spouse could gift them to $48,000 per year, meaning the car would be theirs this year, tax free.

There are some forms of gifting that are exempt from the $12,000 annual limit. Gifts to your spouse, for example, are always tax free as long as he/she is a U.S. citizen. Gifts to political organizations and charities are also exempt.

But you want to on pass your money to family members, your children or grandchildren. Under the rules of the gift tax, you can pay for their education as long as you pay the educational institution directly. So if your grandson's college tuition is $20,000 a year, you could pay it tax free as long as you pay it directly to the college. Now that is a gift both your grandson and his parents will enjoy!

Should the need arise, you could do the same for medical expenses. You can pay someone else's medical bills on their behalf tax free as long as you pay the medical institution directly.

Remember that the $12,000 annual limit is per calendar year. If you miss a year you can't go back and make it up. The estate tax is currently scheduled to end in 2010. If it is not renewed the gift tax rules may change.