General Gifting

Any person can gift money or assets to anyone they choose. Gifts are currently tax free up to specified annual and lifetime limits (see The Gift Tax, below). Gifts are commonly used to:

Pass money from one generation to the next
Give money to organizations
Provide financial aid to friends or relatives in need
Set up educational savings plans

Gifts can also come in noncash form, which can include personal property, free use of living quarters, and more.

The Gift Tax

If the fair market value of your annual gifts to any one individual exceeds $12,000 in a single year, or the total gifts you give beyond this $12,000 annual limit exceed $1 million over your lifetime, you must pay a gift tax. (Couples can gift up to $24,000 per individual recipient per year—$12,000 per member of the couple.)

For example, say that Jane Smith gifts $112,000 to Bill Jones each year. She thus exceeds the $12,000 annual gift limit by $100,000 each year. After 10 years, Jane has given Bill exactly $1 million in excess of the $12,000 annual limit. Any additional gifts she gives to Bill (or to anyone else) over her lifetime beyond the annual exclusion of $12,000 are now subject to gift tax.

To pay the gift tax, file a gift tax return. Gift tax rates are the same as the maximum estate tax rates—roughly 45–50%. Though you don’t need to file a gift tax return for amounts of $12,000 or less each year, you must keep track of all gifts in excess of the annual exclusion because they count against your lifetime gift tax exclusion amount ($1 million).

The Benefits of Gifting

By giving away assets through gifts of $12,000 or less, you can pass on money to your heirs tax free while simultaneously reducing the size of your estate and the eventual tax burden on that estate. While gifting may not be right for individuals who need money themselves, for older or wealthier people looking to pass on their wealth tax free, it’s an option worth discussing with your financial advisor.

Educational Savings Plans (529 Plans)

529 plans allow you to contribute after-tax dollars to an educational savings plan for your relatives (or for anyone else, including yourself). The advantage of these plans is that they allow money to grow and be used free of income or capital gains taxes. Often, grandparents fund these accounts using part or all of their $12,000 per recipient gift tax exclusion amount.

529 plans offer another key benefit, called five-year forward averaging. Five-year forward averaging allows the owner of the 529 plan to gift five years’ worth of money for each recipient free of gift taxes (with a cap of $60,000 as of 2006). Five-year forward averaging lowers the plan owner’s future estate tax burden by moving money into a tax-sheltered account. The only catch: you can’t contribute additional money to the 529 plan for the five years following your initial lump sum contribution.

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